Adam Smith, the 18th century philosopher renowned as the father of economics, has wrote in 1776 in 'The Wealth of Nations': "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own self interest... Every individual intends only his own security, only his own gain. And he is in this led by an invisible hand to promote and end which was no part of his intention, By pursuing his own interest, he frequently promotes that of society more effectually than when he really intends to promote it."
Many free-market advocates regard Smith's interpretation as the right way of how economies should work and even more so, the efficiency of market economies is then interpreted to suggest that a government should not interfere with individuals' selfish attempts to maximize their own interests.
The sad reality is that Adam Smith's 'invisible hand' is only partly true and it has a relatively small span. The 'invisible hand'(when everybody tries to maximize their own interest) might produce a poor outcome for society as a whole. A classic example that refutes Smith's interpretation is the Prisoner's Dilemma.
The prisoner's dilemma is considered a paradox in decision making analysis in which two individuals, acting in their self interest, pursue courses of action that lead to a mutually unfavourable outcome. Suppose, for example, that two individuals are suspected of committing a crime and are interrogated in separate rooms. Both are given the option of pleading guilty or not guilty. If both can withstand this treatment and plead that they aren't guilty, each will be sentenced to 3 years' imprisonment. If person A pleads guilty while person B holds out, A will get away with 1 year and B will get the harsh sentence of 25 years. Of course, the tables will be turned if person B pleads guilty while person A stand firm. If both confess, they will receive 10 years each.
Dominant strategies arise for both. If person A holds out, than person B can either confess(and get away with 1 year) or stand firm(and receive 3 years). If A, however, confesses, than B can either confess(and receive 10 years' imprisonment) or hold out(and receive 25 years' imprisonment). So it is in his own interest to confess. It is his dominant strategy. The same applies for person A. Thus they both confess and receive 10 years' imprisonment. If only they would have plead not guilty then they would have gotten the much more manageable sentence of 3 years each.
The most common type of prisoner's dilemma that arises in the real world is an iterated prisoner's dilemma(a prisoner's dilemma played repeatedly by the same participants). An iterated prisoner's dilemma differs from the original concept because participants can learn about the behavioural tendencies of their counterparty.
Usually, as depicted in 'Thinking strategically' by A. K. Dixit and B. J. Nalebuff, those who find themselves in a prisoner's dilemma might look to cooperate with each other in order to achieve the mutually preferred outcome. But the underlying problem is that the players will have a incentive to cheat on any agreement. Coming back to our example, suppose both individuals come to an agreement(before the interrogation) on holding out and receiving 3 years each. We can easily see that both will have the tendency to defect the other and receive the better sentence(1 year).
Thus Professors Dixit and Nalebuff propose that, after coming to an agreement in an iterated prisoner's dilemma, we should create a system that detects cheating(relatively easy to implement) and punishes the cheaters(usually through a monetary penalty) but only according to the gravity of the mistake. The system should be flexible(forgiving when cheating appears to be an exception) but not too provocable(punishing when cheating appears to be the rule) so that opportunism on the part of your 'associate' will be self-defeating.
In the next post we will take a closer look at how a prisoner's dilemma arises in the real world and everything that we've talked about can be implemented.
The most common type of prisoner's dilemma that arises in the real world is an iterated prisoner's dilemma(a prisoner's dilemma played repeatedly by the same participants). An iterated prisoner's dilemma differs from the original concept because participants can learn about the behavioural tendencies of their counterparty.
Usually, as depicted in 'Thinking strategically' by A. K. Dixit and B. J. Nalebuff, those who find themselves in a prisoner's dilemma might look to cooperate with each other in order to achieve the mutually preferred outcome. But the underlying problem is that the players will have a incentive to cheat on any agreement. Coming back to our example, suppose both individuals come to an agreement(before the interrogation) on holding out and receiving 3 years each. We can easily see that both will have the tendency to defect the other and receive the better sentence(1 year).
Thus Professors Dixit and Nalebuff propose that, after coming to an agreement in an iterated prisoner's dilemma, we should create a system that detects cheating(relatively easy to implement) and punishes the cheaters(usually through a monetary penalty) but only according to the gravity of the mistake. The system should be flexible(forgiving when cheating appears to be an exception) but not too provocable(punishing when cheating appears to be the rule) so that opportunism on the part of your 'associate' will be self-defeating.
In the next post we will take a closer look at how a prisoner's dilemma arises in the real world and everything that we've talked about can be implemented.
Comments
Post a Comment