The Prisoner’s dilemma is a classic model in game theory. It demonstrates why two parties may choose not to cooperate, even when it would be in their best interest to do so.

How the game works:

• Two parties can either cooperate or betray each other.
• If both cooperate, they both receive a moderate reward.
• If one betrays and the other cooperates, the betrayer gains a high profit while the other loses.
• If both betray, both receive a low reward.

Application to business:

• In an oligopoly (a market with few firms), companies could earn more profit by working together to keep prices high.
• However, each company has a strong individual incentive to cheat by lowering prices secretly to gain more customers.
• The result is often a price war, where both companies end up with lower profits than if they had simply cooperated.

Key takeaways:

• The Nash equilibrium occurs when both parties act in their own self-interest and choose to betray.
• It highlights the conflict between individual rationality (what is best for one) and group rationality (what is best for the group).
• This concept explains why cartels are often unstable and why governments create laws to ensure fair competition.