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Ten Principles of Economics - Part 36

Ten Principles of Economics - Part 36. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 16 OLIGOPOLY 361 Iraq s Decision High Production Low Production High Production Iraq gets 40 billion Iran gets 40 billion Iraq gets 30 billion Iran gets 60 billion Iran s Decision Iraq gets 60 billion Iran gets 30 billion Iraq gets 50 billion Iran gets 50 billion Low Production Figure 16-3 An Oligopoly Game. In this game between members of an oligopoly the profit that each earns depends on both its production decision and the production decision of the other oligopolist. result is the inferior outcome from Iran and Iraq s standpoint with low profits for each country. This example illustrates why oligopolies have trouble maintaining monopoly profits. The monopoly outcome is jointly rational for the oligopoly but each oligopolist has an incentive to cheat. Just as self-interest drives the prisoners in the prisoners dilemma to confess self-interest makes it difficult for the oligopoly to maintain the cooperative outcome with low production high prices and monopoly profits. OTHER EXAMPLES OF THE PRISONERS DILEMMA We have seen how the prisoners dilemma can be used to understand the problem facing oligopolies. The same logic applies to many other situations as well. Here we consider three examples in which self-interest prevents cooperation and leads to an inferior outcome for the parties involved. Arms Races An arms race is much like the prisoners dilemma. To see this consider the decisions of two countries the United States and the Soviet Union about whether to build new weapons or to disarm. Each country prefers to have more arms than the other because a larger arsenal gives it more influence in world affairs. But each country also prefers to live in a world safe from the other country s weapons. Figure 16-4 shows the deadly game. If the Soviet Union chooses to arm the United States is better off doing the same to prevent the loss of power. If the Soviet Union chooses to disarm the United States is better off arming because doing so would make it more .