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Agreement Between Oligopolists

For example, game theory may explain why oligopolies have difficulty maintaining collusive agreements to generate monopoly gains. While together, companies would be better off if they worked together, each company has a strong incentive to defraud and under-coerce competitors in order to increase their market share. Because the incentive to default is strong, companies cannot even enter into a collusive agreement if they do not perceive that there is a way to effectively punish defectors. Members of an oligopoly may also face a prisoner dilemma. If each of the oligopolists participates in the humiliation of production, high monopoly gains are possible. However, each oligopolist must be concerned that other companies, while curbing production, are using the high price by increasing production and making higher profits. Table 4 shows the inmate`s dilemma for a two-year-old oligopoly, known as a duopoly. If companies A and B agree to maintain production, they act together as a monopoly and earn $1,000 each. However, the dominant strategy of the two companies is to increase production, each making $400 in profits. Since oligopolists cannot sign a legally enforceable contract to act as a monopoly, companies can instead closely monitor what other companies produce and calculate.

Alternatively, oligopolists can choose to act in such a way that each company under-pressure to stick to its agreed production volume. The game is described as a dilemma, because if the two prisoners had cooperated by keeping each other silent, they would have had to serve only a total of four years in prison between them. If the two prisoners can develop a form of cooperation so that neither of them will confess, they will be better off than if they each followed their own self-interest, which in this case will lead directly to longer prison sentences. The prisoner`s dilemma is a specific type of game in game theory that shows why collaboration can be difficult to hold for oligopolists, even if it is beneficial for both parties. In the game, two members of a criminal gang are arrested and imprisoned. The prisoners are separated and left to see their possibilities. If both prisoners confess, each is serving a two-year prison sentence. If one confesses, but the other denies the act, the one who confessed becomes free, while the one who denied the crime received a three-year prison sentence.