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Game theory: the prisoner’s dilemma
How can game theory: the prisoner’s dilemma support strategic choice or positioning?
Contents
Firms don’t always think directly about what is right for their customers; sometimes they also think strategically about how their competitors will behave, and adapt their own behaviour accordingly.
Game theory analyses decisions in which each participant’s outcome depends partly on what others choose. The prisoner’s dilemma is its best-known illustration of a social dilemma: individually rational choices can produce a result that is worse for everyone.
When to use it
- To structure a consequential choice involving strategic rivals or partners.
- To anticipate competitor responses rather than treating them as fixed.
- To prepare negotiations, auctions, market entry, pricing or cooperation.
Origins
John von Neumann’s 1928 work helped establish modern game theory, and his 1944 book with Oskar Morgenstern connected it to economic behaviour. At RAND, Merrill Flood and Melvin Dresher devised the interaction now known as the prisoner’s dilemma in 1950; Albert Tucker supplied the prison-sentence story and memorable name. Research then expanded into equilibrium, repeated interaction, bargaining, auctions, politics and business. A Nash equilibrium is a set of choices in which no player can improve its payoff by changing alone, given what the others do.
What it is
A “game” specifies the players, available actions, information, order of moves and payoffs. A payoff may represent profit, market share, time, risk or another outcome valued by the player.
In the prisoner’s dilemma, two suspects decide separately whether to confess. If both confess, each receives ten years. If only one confesses, that person receives one year and the other receives 25 years. If neither confesses, each receives three years.
Confessing is individually dominant under those payoffs: it produces a better personal outcome regardless of the other prisoner’s choice. Both therefore confess and receive ten years, even though mutual silence would have given both a better result. The model shows how incentives and inability to make a credible cooperative commitment can defeat collective welfare.
Real business games differ. Interaction may be repeated, moves may be sequential, information may be incomplete and payoffs uncertain. Some games are zero-sum, while others allow participants to create additional value through cooperation. The model is useful only when those differences are represented explicitly.
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