The Prisoner’s dilemma is a famous subject in game theory, and beyond. Here I will first explain it in its simplest form and then its relevancy to real estate economics.
Explanation
The Prisoner’s dilemma, as a story, depicts two prisoner’s (I and II) that are interrogated separately. They are involved in the same crime and when they both keep their mouth shut to the police officer, ‘cooperate’, they face a one year sentence. If they both ‘defect’ and tell on each other, they both face a two year sentence. So, ‘cooperating’ is best for both. However, if one stays silent and the other tells on the one, the one gets a three year sentence and the other gets off with no sentence. This leads to the outcome that both defect and the worst outcome for them combined becomes reality. Why this happens will be explained further now.
| Cooperate | Defect | |
|---|---|---|
| Cooperate | 1 ; 1 | 3 ; 0 |
| Defect | 0 ; 3 | 2 ; 2 |
The Prisoner’s dilemma is depicted in the table above. The left column gives the actions of prisoner I and the top row that of prisoner II. The remaining four cells respectively give the prison sentence for prisoner I and II in each situation. So “3;0” means that prisoner I cooperates, prisoner II defects and that as a consequence I gets a 3 year sentence and II is set free. When prisoner I considers what to do he can assume two situations: prisoner II cooperates or defects. In the first situation, II cooperates, it is better to defect, because no sentence is better than 1 year. In the second situation, II defects, it is better to defect too, because 2 years is better than 3 years. So, regardless of what II does, it is always better to defect for I. Because the same holds the other way round, II will always defect too. So this makes the situation a dilemma, as the rational outcome, a total of 4 years in sentences, is also the worst possible total outcome.
Relevancy for real estate
The Prisoner’s dilemma is relevant to real estate because real estate stakeholders may find themselves in similar situations. For example, neighboring real estate owners might cooperate in improving their surroundings to raise their rental income. But there could be situations where the Prisoner’s dilemma applies: the best result is when both invest in these improvements, but each is better off free riding and letting the other party believe they will cooperate. In practice these owners might not invest the optimal amount, but a sub-optimal amount to hedge against a (partially) defecting neighbor. On the other hand, these owners can enter in a contract describing what each will do. Another option is retaliation: the best result in the Prisoner’s dilemma can become stable if both parties can retaliate in indefinite subgames (say: each year the owners decide again what they both will invest).
Another example is when municipalities compete for companies to operate facilities in their area. Often this is a special case of the Prisoner’s dilemma, also known as the Tragedy of the commons. Competition between municipalities, mostly, does not raise the number of companies. So it could be that municipalities hand out plots cheaper, or lower taxes, to attract companies while for all municipalities in total that means that plots, or taxes, merely raise less money. For all municipalities it is best to cooperate and prevent a race-to-the-bottom, but in practice the marginal benefit of attracting an extra company might be bigger than the cost. In that situation, again the worst outcome is also the rational outcome.
A way out in these situations is a so-called social planner that interferes to achieve the optimal outcome. This social planner can achieve the optimal outcome for example by getting parties to the table, ‘decreeing’ the preferred outcome or by fining parties that defect. Nobel Prize winner Elinor Ostrom has written extensively about governing these commons.
Sources and more reading
Wikipedia, Prisoner’s dilemma