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It was later formalized and named by Princeton mathematician, Albert William Tucker. As a result, it finds application in diverse areas ranging from business, finance, economics, and political science to philosophy, psychology, biology, and sociology. The prosecutor has separately told them the following:. What should the suspects do? The first numeral in cells a through d shows the payoff for Suspect A, while the second numeral shows it for Suspect B. The dominant strategy for a player is one that produces the best payoff for that player regardless of the strategies employed by other players.
The dominant strategy here is for each player to defect i. Here are the possible outcomes:. So if A confesses, they either go free or get two years in prison. But if they do not confess, they either get one year or three years in prison. B faces exactly the same dilemma.
Clearly, the best strategy is to confess, regardless of what the other suspect does. In the above example, cooperation—wherein A and B both stay silent and do not confess—would get the two suspects a total prison sentence of two years. All other outcomes would result in a combined sentence for the two of either three years or four years.
In reality, a rational person who is only interested in getting the maximum benefit for themselves would generally prefer to defect, rather than cooperate. If both choose to defect assuming the other won't, instead of ending up in the cell b or c option—like each of them hoped for—they would end up in the cell d position and each earn two years in prison.
This dilemma, where the incentive to defect not cooperate is so strong even though cooperation may yield the best results, plays out in numerous ways in business and the economy, as discussed below. Often, many sectors of the economy have two main rivals. In the U. This competition has given rise to numerous case studies in business schools. Consider the case of Coca-Cola versus PepsiCo, and assume the former is thinking of cutting the price of its iconic soda.
If it does so, Pepsi may have no choice but to follow suit for its cola to retain its market share. This may result in a significant drop in profits for both companies. A price drop by either company may thus be construed as defecting since it breaks an implicit agreement to keep prices high and maximize profits. Thus, if Coca-Cola drops its price but Pepsi continues to keep prices high, the former is defecting, while the latter is cooperating by sticking to the spirit of the implicit agreement.
In this scenario, Coca-Cola may win market share and earn incremental profits by selling more colas. The payoff matrix looks like this the numbers represent incremental dollar profits in hundreds of millions :. For example, if two firms have an implicit agreement to leave advertising budgets unchanged in a given year, their net income may stay at relatively high levels.
If the other confesses, then one had better do the same to avoid the especially harsh sentence that awaits a recalcitrant holdout. Thus, confession is the dominant strategy see game theory for each. But when both confess, the outcome is worse for both than when both keep silent.
Tucker, a Princeton mathematician. Consider two firms, say Coca-Cola and Pepsi, selling similar products. Each must decide on a pricing strategy.
They best exploit their joint market power when both charge a high price; each makes a profit of ten million dollars per month. If one sets a competitive low price, it wins a lot of customers away from the rival.
Suppose its profit rises to twelve million dollars, and that of the rival falls to seven million. If both set low prices, the profit of each is nine million dollars. Call the former cheating, and the latter cooperation. Arms races between superpowers or local rival nations offer another important example of the dilemma. Both countries are better off when they cooperate and avoid an arms race. Yet the dominant strategy for each is to arm itself heavily.
When each person in the game pursues his private interest, he does not promote the collective interest of the group. Therefore companies that pursue their own self-interest by cheating on collusive agreements often help the rest of society. Similarly, cooperation among prisoners under interrogation makes convictions more difficult for the police to obtain.
One must understand the mechanism of cooperation before one can either promote or defeat it in the pursuit of larger policy interests. Generally, the resource of interest is easily available to all individuals without barriers i. This leads to over-consumption and ultimately depletion of the common resource, to everybody's detriment. Basically, it highlights the concept of individuals neglecting the well-being of society in the pursuit of personal gain.
In the real world most economic and other human interactions are repeated more than once. This allows parties to choose strategies that reward co-operation or punish defection over time. Another solution relies on developing formal institutional strategies to alter the incentives that individual decision makers face. Prisoner's dilemma can sometimes actually make society better off as a whole.
A prime example is the behavior of an oil cartel. All cartel members can collectively enrich themselves by restricting output to keep the price of oil at a level where each maximizes revenue received from consumers, but each cartel member individually has an incentive to cheat on the cartel and increase output to also capture revenue away from the other cartel members.
The end result is not the optimal outcome that the cartel desires but, rather, an outcome that benefits the consumer in terms of lower oil prices. Behavioral Economics.
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What Is the Prisoner's Dilemma? Key Takeaways A prisoner's dilemma is a situation where individual decision-makers always have an incentive to choose in a way that creates a less than optimal outcome for the individuals as a group. The prisoner's dilemmas occur in many aspects of the economy. People have developed many methods of overcoming prisoner's dilemmas to choose better collective results despite apparently unfavorable individual incentives.
What Is the Tragedy of the Commons?
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