Economics 101: The prisoner dilemma, talking or not
The prisoner’s dilemma is a parable about two individuals who have jointly committed a crime considering how much to confess to detectives.
The lessons one gains from studying this peculiar scenario apply to a huge array of important settings in economics, including the most fundamental transaction that underlies all of our prosperity – commercial exchange.
In the original prisoner’s dilemma, the two prisoners are held in separate cells from which they cannot communicate. They are suspected of committing a major offence, but without a confession, the district attorney can only indict them for a minor offence. If, upon interrogation, each remains quiet, the two will serve one year for the minor infraction. If one remains quiet while the other betrays his friend, the betrayer walks away free, while the betrayed is jailed for 10 years. If they both betray each other, then each serves six years. While it is in their collective interest to keep quiet, each has an incentive to betray the other.
How does this apply to commercial exchange? Consider a fictitious UAE citizen, Ahmad, who wishes to purchase a TV online from a fictitious UAE-based electronics retailer, iElectronics, for Dh2,000. Ahmad is willing to pay up to Dh3,000 for the TV, while it costs iElectronics Dh1,000 to sell it. Therefore, if Ahmad buys the TV, each party will obtain Dh1,000 worth of benefit.
Executing the transaction is not so simple, however. Once Ahmad communicates his desire to purchase the TV to iElectronics, each of the two parties has a choice between two alternatives. Ahmad can send the money or not; and iElectronics can deliver the TV or not. For simplicity, let us set aside the possibility of complaining to the authorities if one side reneges on its commitment. Then this situation shapes up the same way as the original prisoner’s dilemma. So what choice will Ahmad and iElectronics make?
To analyse this situation, economists use “game theory”: the study of decision-making when the players’ choices are interdependent, meaning that what one party wants to do depends on what other parties are doing.
Let us suppose that iElectronics will send the TV; should Ahmad pay? If he does, he benefits Dh3,000 minus Dh2,000 = Dh1,000. If he does not, he benefits Dh3,000. Thus, setting aside morals, it serves his interests to refrain from paying.
What if iElectronics does not send the TV? If Ahmad pays, he loses Dh2,000; and if he does not pay, he neither gains nor loses anything. Thus again, it serves his interests to refrain from paying.
Thus, whatever iElectronics does, Ahmad’s interests are best served by his refraining from paying.
The retailer faces an equivalent dilemma. If Ahmad pays and it sends the TV, it gains Dh2,000 minus Dh1,000 = Dh1,000; and if it does not, it profits Dh2,000. If Ahmad refrains from paying, sending the TV loses iElectronics Dh1,000, while the retailer neither gains nor loses should it keep the TV. Therefore, its interests are best served keeping the TV, whatever Ahmad does.
Thus, game theory predicts that neither Ahmad nor iElectronics will perform their side of the bargain, and the result is both sides gaining nothing, just like the two prisoners betraying each other and suffering a worse outcome. If the two sides could trust each other, then they could each profit by Dh1,000; but the opportunity to exploit the other side’s trust prevents the gains from being realised. The key is that the interests of each individual are incompatible with those of the collective, and individuals are the ones who make the decisions.
The breakdown of commerce is a serious issue in the GCC. Many GCC citizens are reluctant to buy online precisely because they fear being cheated by sellers, forcing society to dedicate lots of resources to brick-and-mortar stores.
In addition to explaining the weakness of certain types of commerce, the prisoner’s dilemma also explains why groups often fail to organise contributions to a public good (known as the tragedy of the commons), and why countries struggle to open their economies to each other according to trade accords. These are common problems in the GCC and beyond.
An especially timely application for the GCC is Opec and its accord with non-Opec oil producers. In principle, if they can all cut their output together, they will all benefit; however, each producer faces a temptation to cheat on its quota – a temptation made more acute by the difficulty of objectively measuring production. In the period 1980 to 2009, according to a research paper published in 2011 by the American political scientist Jeff Colgan, Opec producers have cheated 96 per cent of the time. That represents the classic outcome of the prisoner’s dilemma; most analysts expect a similar outcome this time around.
Are decision-makers doomed to succumb to their own selfishness? There are two primary solutions to the prisoner’s dilemma. The first is introducing repetition, so that when Ahmad observes iElectronics cheating today, it can punish him tomorrow. The second is external enforcement, whereby a third party enforces good behaviour by wielding a capacity to punish cheaters. We will explore these in more detail in the coming weeks.
Omar Al Ubaydli is the programme director for international and geopolitical studies at the Bahrain Center for Strategic, International and Energy Studies, and an affiliated associate professor of economics at George Mason University in the US. He welcomes economics questions from readers via email (email@example.com) or tweet (@omareconomics).
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Updated: January 7, 2017 04:00 AM