Adjusting to the Long-Run Tendency of Profit Elimination

212 Part III: Market Structures and the Decision-Making Environment

1. Determine how Clara responds to Bob’s decisions.

If Bob introduces a new menu item, Clara should also introduce a new menu item because her monthly profit is $1,700 instead of $1,400. If Bob doesn’t introduce a new menu item, Clara should introduce a new menu item because her monthly profit is $3,000 instead of $2,000. Introducing a new menu item is a dominant action for Clara because its payoff is always higher than not introducing a new menu item.

2. Determine how Bob responds to Clara’s decisions.

If Clara introduces a new menu item, Bob should also introduce a new menu item because his monthly profit is $1,600 instead of $1,000. If Clara doesn’t introduce a new menu item, Bob should introduce a new menu item because his monthly profit is $2,400 instead of $2,100. Introducing a new menu item is a dominant action for Bob because its payoff is always higher than not introducing a new menu item.

3. Determine the ultimate payoff.

Because introducing a new menu item is the dominant action for both

Bob and Clara, the ultimate payoff is in the upper left cell of the payoff table. Bob’s Barbecue receives $1,600 profit and Clara’s Cafeteria receives $1,700 profit.

This example leads to a prisoner’s dilemma because Bob and Clara ultimately receive profits that are less than optimal. If both Bob and Clara decide not to introduce a new menu item, both receive more profit — $2,100 for Bob and $2,000 for Clara. But Bob and Clara don’t do that, because in that situation, each could make more profit by introducing a new menu item. If Bob introduces a new menu item, his profit goes to $2,400, but Clara’s profit goes down to $1,400. So, Clara is “forced” to also introduce a new menu item to get her profit from $1,400 to $1,700, but Bob’s profit goes down to $1,600. Similarly, if Clara introduces a new menu item, her profit goes to $3,000, but Bob’s profit goes down to $1,000. So, Bob is “forced” to also introduce a new menu item to get his profit from $1,000 to $1,600, but then Clara’s profit goes down to $1,700. By acting out of self interest, both Bob and Clara end up with smaller profit, but ignoring what their rival does is even worse.

With a prisoner’s dilemma, players chose the action that best serves their own interests. However, the result of this behavior is a combined payoff that’s less than optimal.

Sequential-move, one-shot games

In many games, one player chooses before another, and it’s difficult to know who has the advantage. As I note earlier in this chapter, in chess, if you move first, you have a greater probability of winning. On the other hand, in