|Posted on April 16, 2014 at 8:45 PM|
A prisoner dilemma occurs when each firm's respective payouts are greater if each firm does NOT play its dominant strategy. In the game theory matrix below, the dominant strategy for both firms are to play Strategy A and the cell outlined in red is the Nash equilibrium.
However, if both firms play Strategy B then their payout are greater. If the firms collude and agree to play Startegy B, the dilemma is whether each firm can trust the other to play Strategy B and not Strategy A. Without a commitment device, each firm has an incentive to cheat to gain greater profit. The likely outcome is that they will both cheat and end up in the original Nash equilibrium.
AP Microeconomics Unit 2 Product Markets