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2) Why do economists believe that the pricing war between firms as a situation similar to...

2) Why do economists believe that the pricing war between firms as a situation similar to prisoner's dilemma game?

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Answer #1

In a Prisoner's dilemma game, each prisoner has two options: Confess and Don't confess. The most optimal outcome is achieved by both the prisoners if both don't confess, but they are worried that the other will confess, resulting in a much worse outcome for the one who doesn't. Hence both end up confessing, and get the worst outcome collectively.

Pricing war is very similar. Reduce the price is aking to Confess, and not reducing the price is similar to Don't confess. Both the firms eventually end up dropping the price resutling in erosion of profits for both of them, which they could have maintained if they both didn't drop the price. But they are worried that the other would drop prices.

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