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Monday, April 11, 2011

Game Theory Prisoner's Dilemma at

Game Theory is a widely used concept in Economics. It is defined as those techniques which are used to identify how the price, supply and demand of a particular product influences a group of people.

It is one the techniques that managers of firms under imperfect markets like duopoly, oligopoly, monopolistic competition, etc use to arrive at the optimum price of a product along with the supply and demand interactions.

Game Theory was developed in the 40s in connection with war strategies. Now it is being used by managers to arrive at an optimal price and output for products. As Managers today deal with a higher number of ever changing scenarios, they need to plan ahead for unexpected situations.

Game Theories have several assumptions upon they are based. They include: the players are rational in choosing those actions which gives the output that he prefers and the output that their opponents expect.

Prisoner’s Dilemma

The Prisoner’s Dilemma is a game in strategic form between two players. Each player has only two strategies or moves. One is to “cooperate” and “defect”. This can be explained using an example.

Consider a situation where two friends A and B are arrested for doing something illegal and they are questioned separately. Now, there can be four possible situations that can be arrived at. First is, A confessing to the crime, while B does not. In this case A will be sentenced to 2 years while B is sentenced to 8 years. Second is A does not confess and B confesses. In this case A will be sentenced to 8 years and B 2 years. The third is both of them confess and get 2 years each. The last option is that both of them do not confess and they end up with 8 years of sentence each.

Here, we can observe that both of them are in a dilemma about who confesses first. If A confesses first, then B will have to confess. If B confesses first, then A will have to confess. Even if they are given a chance to talk to each other and arrive at an agreement not to confess, they will still break the agreement and will confess. So, the best option open for them is to confess to the crime and get the least amount of sentence that is 2 years. It is a “win-win situation” for both of them. But, if both of them do not confess, they are calling for more trouble and end up getting a sentence of 8 years each.

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This is in continuation with our previous articles on Economics which inlcude: Neoclassical Economics, Solow Growth Model, Philip's Curve, Oligopoly

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