🛒principles of microeconomics review

key term - Prisoner's Dilemma

Definition

The prisoner's dilemma is a classic game theory scenario that demonstrates how two individuals acting in their own self-interest can ultimately produce an outcome that is less than optimal for both parties. It highlights the tension between individual and collective rationality.

5 Must Know Facts For Your Next Test

  1. In the prisoner's dilemma, two suspects are interrogated separately and given the opportunity to either cooperate with the other suspect or defect.
  2. If both suspects cooperate, they receive a lighter sentence, but if one defects while the other cooperates, the defector goes free while the cooperator receives the harshest sentence.
  3. The dominant strategy for each suspect is to defect, even though the optimal outcome for both would be to cooperate.
  4. The prisoner's dilemma highlights how individual rationality can lead to a suboptimal collective outcome, known as the 'tragedy of the commons'.
  5. The prisoner's dilemma is often used to analyze decision-making in oligopolistic markets, where firms may be tempted to undercut each other rather than cooperate.

Review Questions

  • Explain how the prisoner's dilemma relates to the concept of oligopoly.
    • In an oligopolistic market, firms face a similar dilemma to the prisoners in the classic scenario. Each firm has the choice to either cooperate with the other firms by maintaining high prices, or defect by undercutting prices to gain a larger market share. However, if all firms defect, they end up in a worse position than if they had cooperated. This mirrors the prisoner's dilemma, where the individually rational choice to defect leads to a suboptimal outcome for the group as a whole.
  • Analyze the role of dominant strategies and Nash equilibrium in the prisoner's dilemma.
    • In the prisoner's dilemma, the dominant strategy for each individual is to defect, as this maximizes their personal payoff regardless of the other player's choice. However, this leads to a Nash equilibrium where both players defect, resulting in a less desirable outcome for both. The tension between the dominant strategy and the collectively optimal strategy is a key feature of the prisoner's dilemma. Understanding how dominant strategies and Nash equilibria interact in this scenario can provide insights into decision-making in oligopolistic markets, where firms may face similar tradeoffs between individual and collective rationality.
  • Evaluate how the prisoner's dilemma can lead to the 'tragedy of the commons' in oligopolistic markets.
    • The prisoner's dilemma highlights how individual rationality can lead to a suboptimal collective outcome, known as the 'tragedy of the commons.' In the context of oligopolistic markets, this can manifest as firms prioritizing their own short-term profits over the long-term sustainability of the industry. For example, if all firms in an oligopoly defect by engaging in price wars or excessive production, they may each gain a larger market share in the short term, but the resulting oversupply and reduced profitability can ultimately harm the industry as a whole. The prisoner's dilemma illustrates how the pursuit of individual interests can undermine the collective good, a dynamic that is often observed in oligopolistic markets.