Prisoner's Dilemma

The standardized example of prisoner’s dilemma, originally proposed by mathematicians Merrill Flood and Melvin Dresher, and then formalized by Albert W. Tucker, presents the following situation:

• Two members of a criminal gang are arrested and interrogated in separate rooms. There are no other witnesses available, and the authorities only possess sufficient evidence to convict one of the prisoners, but only if the other prisoner testifies against them.
• The authorities offer each prisoner a bargain. They can betray the other prisoner by testifying that the other prisoner committed the crime, or they can cooperate with the other prisoner by remaining silent.

• If both of them remain silent, both serve one year each.
• If both of them betray the other, both serve two years each.
• If one betrays the other, but the other remains silent, the prisoner who testified is set free, and the prisoner who remained silent serves three years.

Betraying the other prisoner offers a greater reward than cooperating with them, so it can be assumed that all purely rational prisoners will betray the other, resulting in the only possible outcome being both prisoners betraying each other. 

Pursuing individual reward logically should lead to a better result; however in a prisoner’s dilemma, pursuing individual reward leads to a worse individual result.

Prisoner’s dilemmas occur in many aspects of the economy, but a variety of solutions have been proposed and implemented over time that favors the common good over individual incentives.

For example, in real-world situations, most interactions are repeated more than once. If a prisoner’s dilemma occurs more than once, it can be referred to as an iterated prisoner’s dilemma. In such a situation, the individual actors can implement strategies that reward cooperation over time.

Another solution is formal, institutional strategies that alter the incentives that individual decision-makers can potentially face. By having an understanding of the collective goals and the ability to enforce cooperative behavior through various sets of rules, prisoner’s dilemmas can be steered towards the more collectively beneficial outcome.