Pricing Dilemmas

The prisoners’ dilemma has numerous applications to business, and not just white-collar crime. Price competition often pushes firms into a prisoners’ dilemma. A business can frequently increase its profits by lowering prices because reducing prices attracts new customers. Many of the new customers will be stolen from the business’s rivals, however. Of course, when all businesses lower prices to steal customers from each other, they all suffer.

Figure 36 illustrates a prisoners’ dilemma game with two firms that can each charge either a high or low price. In this game, regardless of what the other firm does, both firms are better off charging a low rather than a high price. If your rival is charging a low price, then he will get all the customers unless you too have a low price. If your rival charges a high price, you are better off charging a low price to get all of the customers. For both companies, charging a low price is a dominant strategy, so the likely outcome for this game is for both firms to charge low prices.

Figure 36

In the game in Figure 36, the two firms would be better off if they could make a binding agreement to maintain high prices. As with the cops and murderers version of prisoners’ dilemma, however, such an agreement would be difficult to sustain. Each firm would like to pretend to go along with the agreement and then capture all the market by charging a low price while its rival charges a high price.

Another problem with making agreements in this prisoners’ dilemma pricing game is that any agreement would be a violation of antitrust laws and punishable by prison. Antitrust laws were explicitly designed to make it illegal for firms to agree to keep prices high. Consequently, if you make an agreement with your business rival for you both to charge high prices, you might find yourself in a different kind of prisoners’ dilemma. Also, because agreements to charge high prices are illegal, if you made such an agreement and it was violated, you couldn’t sue for damages.