The trap is built from incentives
Imagine two competing businesses deciding whether to keep prices high or offer a discount. If both keep prices high, each earns a healthy margin. If one discounts while the other does not, the discounter may attract more customers. But if both discount, neither wins a lasting advantage—and both earn less per sale.
That last outcome can happen even when each business makes a sensible choice on its own. A manager cannot control what the rival does, so discounting can look like insurance: it prevents the business from being the only one charging more. The rival faces the same calculation. Each protects itself, and together they produce a worse result than they could have achieved by holding prices steady.
Why individually sensible choices can clash
Game theorists use the prisoner’s dilemma to describe this structure. It is not about whether players are kind or foolish; it is about how the payoffs are arranged. Each player has an incentive to choose the action that seems safest given the other player’s possible move, even though mutual restraint would leave both better off.
When each player’s choice is the best response to the other’s, the result is called a Nash equilibrium: neither can improve its position by changing course alone. That does not mean the outcome is best for the group. It means that escaping it requires coordination, trust, or a change in the incentives—not simply a better individual calculation.
Repetition can change the calculation
The dilemma is sharpest when decisions are isolated and players cannot reliably coordinate. If the same rivals meet again, today’s move can affect tomorrow’s response. A business might be more willing to avoid a price cut if it expects the competitor to remember and reciprocate; it may also cut prices to deter future undercutting. Repeated contact can support restraint, but it does not guarantee it.
The striking consequence is that competition can produce a result no competitor actually wants. The lower prices may benefit customers in the short run, while the businesses’ shared margins shrink. The key is not that either side chose irrationally: each acted to avoid being the one left exposed.
