Understanding the Prisoner’s Dilemma in Microeconomics

By Peter Antonioni, Manzur Rashid

Part of Microeconomics For Dummies Cheat Sheet, UK Edition

The prisoner’s dilemma can help you better understand microeconomics. In the prisoner’s dilemma, two people are arrested for a crime and put in separate rooms so that they can’t communicate. The authorities make the same offer to both, one that means that their best option if they could communicate is unattainable. Because neither party can fully trust the other they will default to a Nash Equilibrium that is not as good as the collective best outcome.

In strategy, a Nash Equilibrium is the condition where each player is doing the best they can, given that all other agents are also doing the best they can. A Nash Equilibrium is the best any individual player can do, but it’s possible that a better collective outcome could exist if players were better at co-operating with each other.

So, what’s the Nash Equilibrium used for in cases like the prisoner’s dilemma?

  • Cartels: If cartels could make legally binding contracts then it is possible that they could co-operate and act as a single monopoly. But since cartels are illegal, no one can make that contract, therefore the members can never fully trust each other.

  • Organised crime: Organised crime is an attempt to beat the prisoner’s dilemma. The syndicate uses its power to ensure that none of its members have an incentive to cheat.