OPEC and the Prisoners’ Dilemma

Jun 10, 2011 • Behavioral Economics, Demand, Supply, and Markets, Developing Economies, International Trade and Finance, Macroeconomic Measurement, Thinking Economically • 442 Views    No Comments

Faced with rising prices and pressure to increase production what should OPEC (the Organization of Petroleum Exporting Countries) do? They could not agree.

Why? Maybe it’s the prisoners’ dilemma.

Picture for a moment 2 (guilty) suspects. Questioned by the police, each one can confess or remain silent. When one confesses and the other does not, the talker gets a less severe sentence. If both are silent, then they are released; if both confess, then they get equal jail time. And therein lies the dilemma. Do you base your decision on what you think the other individual will do?

As a cartel, OPEC’s 12 members have a perpetual prisoners’ dilemma. If the cartel assigns quotas, should they observe them? Maybe not if everyone else does. But, if all produce more, then price drops. And now, as one oil analyst said, “Everybody in OPEC is cheating…” You can see why cartel arrangements usually disintegrate.

Mathematician John Nash (1928- ) and 2 other researchers won the 1994 Nobel Prize in economics for “their pioneering analysis of equilibria in the theory of non-cooperative games.” The prisoners’ dilemma is one example of Dr. Nash’s work. 

The Economic Lesson

Game theory is about the “science of strategy” for individuals, business firms and nations.  Mathematically and logically determining who benefits, game theory focuses on individual motivation, cooperative and non-cooperative behavior, and group outcomes. The prisoners’ dilemma is one example of the basics of game theory.

In this econtalk interview, a behavioral economist explains the limits of game theory.

An Economic Question: How might the prisoners’ dilemma relate to Coca-Cola contemplating a price increase for Diet Coke?



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