Page 356 - The Principle of Economics

362 PART FIVE
FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
Figure 16-4
AN ARMS-RACE GAME. In this game between two countries, the safety and power of each country depends on both its decision whether to arm and the decision made by the other country.
Decision of the United States (U.S.)
Arm Disarm
USSR at risk
U.S. at risk
U.S. at risk and weak
USSR safe and powerful
U.S. safe and powerful
USSR at risk and weak
USSR safe
U.S. safe
Arm
Disarm
Decision
of the Soviet Union (USSR)
Throughout the era of the Cold War, the United States and the Soviet Union attempted to solve this problem through negotiation and agreements over arms control. The problems that the two countries faced were similar to those that oli- gopolists encounter in trying to maintain a cartel. Just as oligopolists argue over production levels, the United States and the Soviet Union argued over the amount of arms that each country would be allowed. And just as cartels have trouble en- forcing production levels, the United States and the Soviet Union each feared that the other country would cheat on any agreement. In both arms races and oligopo- lies, the relentless logic of self-interest drives the participants toward a noncoop- erative outcome that is worse for each party.
Advertising When two firms advertise to attract the same customers, they face a problem similar to the prisoners’ dilemma. For example, consider the deci- sions facing two cigarette companies, Marlboro and Camel. If neither company ad- vertises, the two companies split the market. If both advertise, they again split the market, but profits are lower, since each company must bear the cost of advertis- ing. Yet if one company advertises while the other does not, the one that advertises attracts customers from the other.
Figure 16-5 shows how the profits of the two companies depend on their ac- tions. You can see that advertising is a dominant strategy for each firm. Thus, both firms choose to advertise, even though both firms would be better off if neither firm advertised.
A test of this theory of advertising occurred in 1971, when Congress passed a law banning cigarette advertisements on television. To the surprise of many ob- servers, cigarette companies did not use their considerable political clout to op- pose the law. When the law went into effect, cigarette advertising fell, and the profits of cigarette companies rose. The law did for the cigarette companies what they could not do on their own: It solved the prisoners’ dilemma by enforcing the cooperative outcome with low advertising and high profit.