What Is the Prisoner's Dilemma?

The prisoner's dilemma is a simple concept in the psychology of decision-making that has applications in various fields such as economics and finance. In the concept, two rational entities cooperate for mutual benefit or benefit themselves for individual rewards.

In the case of two different prisoners, they have the option to snitch on their counterparts to receive a lower prison time or stay silent to minimize prison time for both parties. However, the prisoners make these decisions based on preemptive assumptions of the other individual. They may stay silent or vice versa if they believe the other prisoner is trustworthy. This concept of decision-making based on preemptive assumptions is prevalent in the economy.

Real-Life Examples

Prisoner's dilemma is frequently applied in economics and can be seen in many market structures:

1. [ General Example ]- If two large firms with similar products are deciding on pricing strategies, one may choose a lower price for their product leading to higher profit, while the other firm increases their price leading to lower profit. This situation is akin to Prisoner A confessing and Prisoner B keeping quiet. If the two firms were to choose the lower pricing strategy or higher strategy together, there would be a mutual benefit for each firm.

2. [ Specific Example ]- Cartels in an oligopoly market ( market dominated by a select amount of firms ) can also be seen as a prisoner's dilemma as each firm benefits itself by setting similar prices and output restrictions which is mutually beneficial. However, each cartel member has the motivation to cheat to benefit their firm. In this case, the incentive to cheat would benefit society as lower prices would make the goods more affordable.

This array of examples shows how the cornerstone concept of prisoner's dilemma in economics and finance is generally used to display decision-making, however over time with frequent instances of the dilemma, firms can strategize and formulate a plan that benefits both parties.

This simple concept has complexities and real-world applications far beyond the example of prisoners. The Prisoner’s Dilemma is more than just a psychological concept, but is something we can all utilize whether we’re large industrial firms or normal everyday people!