Prisoners Dilemma

The Prisoner’s Dilemma, when applied to oligopoly theory, highlights the paradox faced by firms: even though cooperation could lead to mutual benefit, the pressure of competition often pushes them to act in their own self-interest, resulting in worse outcomes for all involved.

Consider the classic scenario involving two individuals, Billa and Ranga, who are caught by the police and offered a deal. The terms are simple: if one confesses while the other stays silent, the confessor receives a light sentence of 1 year, while the silent one is handed a harsh 10-year sentence. If both confess, they each get a moderate sentence of 5 years. However, if both remain silent, they both get off with just 1 year each.

Despite the possibility of a relatively light sentence through mutual cooperation (remaining silent), both Billa and Ranga, driven by the fear of being betrayed and getting stuck with the harsh 10-year sentence, end up confessing. In the end, they each serve 5 years—an outcome worse than if they had simply stayed silent and cooperated.

This scenario mirrors the dynamics in oligopolistic markets, where firms, despite knowing that cooperation (such as price-fixing or collusion) could lead to higher profits for all, often choose to act in their own self-interest to avoid the risk of being outdone by competitors. Just as Billa and Ranga end up with a worse outcome than if they cooperated, firms in an oligopoly often end up in a competitive “race to the bottom,” where they all suffer rather than benefiting from mutual cooperation.