Why do people make decisions that don’t seem to make sense?
Game theory provides a potential answer called the prisoner’s dilemma. The prisoner’s dilemma explains why people make decisions which are good for themselves but not for the team. Even if you didn’t learn about it in economics class, you probably recognize the prisoners’ dilemma from TV cop shows. Here’s how it works:
The police have enough evidence to convict two criminals of a minor crime. The police suspect the criminals have also committed a major crime but don’t have enough evidence to convict them. To extract a confession, the police question the suspects separately and offer them each an identical deal. The deal is something like this:
‘We already can lock you up for a year for the minor crime. And we’re going get you on the major crime and put you away for 20 years. However, if you confess to the major one and implicate your partner, we will give you immunity and you won’t have to go to jail at all. But you better hurry because we’re making the same offer to your partner. And if you both confess, the immunity deal is off. We’ll give you both 8 years since we avoid a trial.‘
The criminals’ best option is for neither of them to confess. Without one of them confessing, they won’t get convicted of the major crime and will only go to jail for one year for the minor crime.
Criminal A who doesn’t know what the other Criminal B will do. If A thinks Criminal B will confess, Criminal A should also confess so he gets 8 years in jail, rather than 20. If A thinks B won’t confess, Criminal A should confess anyway; by taking the deal, A gets off without any jail time. So regardless of what the other criminal does, the best option for Criminal A is to confess.
Criminal B faces the exact same choices and independently comes to the same conclusion to confess. Both confess to the major crime and go to jail for 8 years, even though they could have limited it to one year if neither had confessed.
The prisoners’ dilemma shows why two people or companies might not cooperate even when it is in their collective best interests. In the language of game theory, they are employing a minimax strategy – minimizing their maximum loss. Despite its name, the dilemma applies to a wide range of situations in business.
In the case of the Coke v Pepsi cola wars, each have similar market share for a price-sensitive commodity. If one of them lowers prices to gain customers, the other is likely to do the same. As a result, neither of them gains momentum but ends up with lower prices. This is analogous to the prisoners confessing when they should remain silent. The best option for both Coke and Pepsi is to keep prices as-is but the reality of perpetual promotions shows they both fall prey to the prisoner’s dilemma.
The prisoner’s dilemma also explains why OPEC has had a hard time keeping oil production and therefore prices high. It’s frequently cited as the cause for arms races between superpowers and unsustainable military investment between rival nations. The prisoner’s dilemma is even a plausible explanation for illegal doping in sports. In all three cases, one person/company acts in their own interest because they believe everybody else will.
The prisoner’s dilemma may explain all of these situations but it doesn’t justify them. As everyone’s mother said when they were young: Just because your friends jump off a bridge, doesn’t mean you should too.