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Prisoner’s Dilemma

A decision-making and game theory paradox that illustrates the decisions of two rational individuals cannot result in an optimal solution

What is a Prisoner’s Dilemma?

A prisoner’s dilemma is a decision-making and game theory paradox illustrating that two rational individuals making decisions in their own self-interest cannot result in an optimal solution. The paradox was developed by mathematicians M. Flood and M. Dresher in 1950, and the modern interpretation was conceptualized by Canadian mathematician A.W. Tucker.

The prisoner’s dilemma may be expressed as an approach where individual parties seek their welfare at the expense of the other party. Generally, since both participants avoid cooperation in the decision-making process, they end up in a much worse condition.

 

Prisoners Dilemma Diagram

 

In the prisoner’s dilemma theory, it is the responsibility of the two parties to choose whether to collaborate or not. Either party is given the chance to defect, despite the option of the other party. The outcomes of the prisoner’s dilemma are either beneficial or injurious to society. Making better economic choices require cooperation between individuals.

 

Summary

  • The prisoner’s dilemma represents a scenario where decision-makers apply a stimulus that creates a less than optimal outcome.
  • Individuals can choose among different ways to defeat prisoner’s dilemmas and opt for superior combined results despite adverse incentives.
  • The optimum reward for each individual occurs when both parties agree to work together.

 

Prisoner’s Dilemma Scenario

Imagine that the police arrested two suspects of a crime. Both suspects are held in different cells and they cannot communicate with each other. The police officer offers both suspects the opportunity to either remain silent or blame another suspect. If both suspects remain silent, they both will serve only one year in prison. If they both blame each other, they both will serve three years in prison.

If one of the suspects blames another and the other remains silent, the suspect who remained silent would serve five years in prison, while another suspect would be set free. The table below shows the possible payoffs:

 

Prisoner’s Dilemma

 

Learn more with CFI’s Behavioral Finance Fundamentals Course!

 

Prisoner’s Dilemma Explained

In such a setting, both suspects do not know the decision chosen by another suspect. Therefore, the most rational decision from the perspective of self-interest is to blame the other suspect.

For example, suspect A is afraid of remaining silent because in such a case, he can receive five years in prison if suspect B blames him. If suspect A chooses to blame suspect B, he can be set free if suspect B remains silent. However, that is not likely, because suspect B is using the same rationale and he is also going to blame suspect A.

Although the decision of remaining silent by both suspects provides the more optimal payoff, it is not a rational option because both parties behave in their self-interest. On the other hand, the decision of blaming another suspect is a rational decision from that perspective and it provides Nash equilibrium despite the worse payoff. Learn how scenarios like this affect market behavior on CFI’s Behavioral Finance Fundamentals Course.

 

Avoiding Prisoner’s Dilemma

Individuals can use different formal approaches to modify the incentives that decision-makers encounter. Strategies like combined effort for enforcing cooperative measures through laws, democratic decision-making, rules, and precise punitive action for defections might help in changing numerous prisoner’s dilemmas into beneficial outcomes.

A beneficial outcome can happen because cooperation produces better results than defection. However, it may not be a rational outcome since the decision to cooperate from an individual standpoint is irrational.

However, some parties take advantage of both behavioral and psychological partiality over time, such as long-term interactions influenced by repeated engagements, high levels of trust between individuals, and similar cooperative behaviors either towards negative reciprocity of defection or positive reciprocity of cooperation.

The ideologies above may advance over time within a group of competing participants. Generally, they irrationally influence individuals to select outcomes that provide maximum benefits to society collectively.

 

More Resources

CFI offers the Commercial Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant CFI resources below:

  • Groupthink
  • Interpersonal Intelligence
  • Game Theory
  • Personal Brand

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