TTC - Understanding Economics: Game Theory

Imagine you are a criminal being interrogated by the police. In the next room, your accomplice is being questioned separately. While both of you would be better off keeping your mouths shut, the worst outcome is if you stay silent and your confederate confesses, implicating you and getting a lighter sentence as a reward—so that would actually mean a better outcome for you if you confess and they stay quiet. Game theory predicts that both of you will therefore confess, earning an intermediate level of punishment but forgoing the lesser penalty you both could have had if you had said nothing.

Strategic predicaments like this “prisoner’s dilemma” operate in practically every sphere of life but especially in economics, where competition, price, profit, the quest for market power, and other factors make the marketplace an endlessly interesting arena for game theory.