[doublespanner]

Well no, there is no real dilemma, because unlike the prisoners you can change your choice at any time. You can do research and make a decent guess at the units sold at a price point of you only make a small increase, and then your competition does the same, and as long as you can all keep pushing the price each small increase is absorbed. This is essentially a mechanism for discovering inflation, it continues step by step until people stop buying.

[mitthrowaway2]

The "and then your competition does the same" is precisely what I'm talking about. If their input costs have not gone up, there's no reason they need to do follow in step rather than take your customers away. It doesn't matter whether it happens gradually.

Multilateral increase in margins demonstrates a lack of competitiveness between competitors.

[doublespanner]

It's because both competitors are making the same calculation where a loss in market share is worth less than the per unit profit increase.

This isn't really a matter of competition, it's that people's willingness to pay (in nominal value) is much higher.

If people's willingness to pay were less, then increasing prices would loose a greater portion of the market.

[mitthrowaway2]

How is the calculation you're describing different than the calculation of optimal pricing for a monopoly?

[doublespanner]

It's similar, but when the price of the product is closer to the willingness to pay, market share becomes important again.

It's also has an impact on what products get made, and investment in r&d. If you fall behind the competition in terms of quality, you loose marketshare.