Which of the following legal restrictions, if enforced effectively, would be likely to solve a prisoner’s dilemma type of problem for the firms involved?
A. A law that prevents a cartel from enforcing rules against cheating.
B. A law that makes it illegal for oligopolists to engage in collusion.
C. A law that prohibits firms in an industry from advertising their services.
D. All of the above would be likely to solve a prisoner’s dilemma for the firms.
The correct answer and explanation is:
The correct answer is: B. A law that makes it illegal for oligopolists to engage in collusion.
Explanation:
A prisoner’s dilemma in economics typically arises when firms in an oligopoly face incentives to cheat rather than cooperate, even though cooperation would lead to better outcomes for all involved. For example, if firms try to form a cartel to keep prices high, each firm individually benefits by secretly lowering prices to gain market share. This “cheating” breaks the cartel agreement and leads to worse outcomes (like price wars) for all firms.
Now, let’s analyze the options:
- A. A law that prevents a cartel from enforcing rules against cheating.
If cartels cannot enforce rules, then cheating is easier and more likely to happen. This exacerbates the prisoner’s dilemma because firms have less incentive to stick to cooperative behavior. So, this would not solve the dilemma; it would reinforce it. - B. A law that makes it illegal for oligopolists to engage in collusion.
This law forbids firms from cooperating to set prices or restrict output. While this prevents formal cartels, it forces firms to compete rather than collude. In the prisoner’s dilemma, collusion is the “cooperation” that could benefit firms, but it is unstable without enforcement. Making collusion illegal removes the option to cooperate illegally and can lead to more competitive behavior, reducing the incentive or opportunity to cheat because no formal agreements exist to break. This disrupts the prisoner’s dilemma scenario by eliminating the possibility of collusion itself. - C. A law that prohibits firms in an industry from advertising their services.
Advertising restrictions do not directly address the incentives to cheat or cooperate on prices or output. Advertising affects competition on other dimensions, but it does not solve the core dilemma of trust and incentive to cheat within price-setting behavior. - D. All of the above would be likely to solve a prisoner’s dilemma for the firms.
Since A and C do not solve the problem (and A could worsen it), this option is incorrect.
Summary:
The prisoner’s dilemma arises because firms have incentives to cheat on cooperative agreements. Making collusion illegal (option B) prevents firms from forming these agreements in the first place, which eliminates the “game” where cheating would occur. Therefore, a legal restriction forbidding collusion disrupts the prisoner’s dilemma dynamic by removing the possibility of collusion, pushing firms toward competition instead. This is why B is the best answer.