The Prisoners’ Dilemma in Oil Production
http://seekingalpha.com/article/4004241-game-theory-finest-oil-production-freezes-happen
Recently, OPEC and Russia were having talks in an effort to raise oil prices. Production freezes have been mentioned on multiple occasions in the past but always fail to happen. Each time the countries try to find common ground and strategize how to stabilize oil prices, the same result occurs: more oil production and lower oil prices. The article in the link shown above explains why this is so using game theory. The table below illustrates how game theory predicts the countries’ decisions.
Comparing the respective payoffs for Firm A in each situation: If B cheats, then A should cheat; and if B does not cheat, A still has a higher payoff when cheating. This distribution of payoffs is symmetrical so the same applies for Firm B. Both firms would have a higher payoff when choosing to cheat. Since cheating is the best response for either situation, this is the dominant strategy for all the countries (2,2). We can see that A and B would actually have a greater and equal payoff if both decided to not cheat simultaneously with a payoff of (3,3). But this poses a greater risk for the countries, if another country decides to cheat they would lose tremendously and end up with a payoff of (1,5). So they maintain their dominant strategy to cheat in any case.
This current issue in oil production is a very clear example of the Prisoners’ Dilemma. It shows how game theory can be used to explain decisions of multiple parties when faced with a problem. Ultimately, the best response paired with lowest risk dominates. The countries continue to overproduce and exceed their quota for greater economic gain, deterring them from driving oil prices higher.