The Prisoner’s Dilemma

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Imagine the following situation. You have been imprisoned in a maximum security prison and are being interrogated by an officer. The officer tells you that they are also interrogating your accomplice in a federal crime, and that he is being given the same options that he is about to give you.

If you both refuse to cooperate and neither talks, the officers admittedly will not be able to prove as many crimes as they could have otherwise and the two of you will face a mere year in prison together. However, if you cooperate and your accomplice does not, you will go free while he will be imprisoned for 10 years for the crimes committed. Meanwhile, if the two of you cooperate and rat the other out, then you’ll both face 4 years in prison together. Unaware of what your accomplice will do, what decision do you make? Do you cooperate on the chance that he refuses so that you might go free, or do you refuse to cooperate on the hopes that he too will do so for the most beneficial arrangement for the both of you?

	Your accomplice talks	Your accomplice refuses to cooperate
You talk	The both of you spend 4 years in jail	Your accomplice spends 10 years in jail and you go free
You refuse to cooperate	You spend 10 years in jail and your accomplice goes free	You both spend a year in jail together

As the table indicates, the most beneficial arrangement for the two of you is if neither rats the other out. However, if you act in such a manner and your accomplice does not, he can get away absolutely scot-free while you spend the next 10 years of your life in jail. Why would he accept a year in jail, you think, when he can ensure his freedom by cooperating if you refuse to. Though it is in the common interest of both of you to refuse to cooperate (given that it will lead to a total of 2 years jail time between the two of you), the most probable scenario is that acting in self-interest, you will both talk, leading to an ineffectual and otherwise avoidable 8 years of jail time (between the two of you) had it not been for the asymmetric information which plagues this dilemma.

As indicated by the problem above, intermediation is not always a flawless process that reduces transactions costs in every case. Economists increasingly focus on problems arising from asymmetric information.

Problems of asymmetric information exist when one party to a transaction has better information than other parities, and can gain by exploiting the value of that information.

For example, a dealer might know that a car’s odometer has been altered to show low mileage, but may try to conceal this knowledge from a potential used-car buyer. Thus, government is used to prosecute fraud that arises from asymmetric information – only one of numerous situations where government action seems necessary, even in economies based primarily on market forces.

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Author: Ralph Byrns

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