Syllabus T. Y. B. A. Paper : IV advanced economic theory with effect from academic year 2010-11 in idol

Definition: Nash Equilibrium The position resulting from 
everyone from everyone making their optimal decision based on 
their assumptions about their rivals‘ decisions. Without collusion, 
there is no incentive or any firm to move from this position. 
Definition: 
Prisoner‟s dilemma Where two or more firms (or 
people), by attempting independently to choose the best strategy 
for whatever the other(s) are likely to do, end up in a worse 
position than if they had co-operated in the first place. 
2.5 THE PRISONER‟S DILEMMA: 
Game theory is relevant not just to economics. A famous non-
economic example is the prisoners' Nigel and Amanda have been 
arrested for a joint crime of serious fraud. Each is interviewed 
separately and given the following alternatives: 
■ First, if they say nothing, the court has enough evidence to 
sentence both to a year's imprisonment. 
■ Second, if either Nigel or Amanda alone confesses, he or she 
is likely to get only a three- month sentence but the partner 
could get up to ten years. 
■ Third, if both confess, they are likely to get three 
Figure 2.4 
 
WHAT SHOULD NIGEL AND AMANDA DO?
Let us consider Nigel‘s dilemma. Should he confess in 
order in order to get the short sentence (the maximax strategy)? 
This is better than the year he would get for not confessing. There 

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is, however, an even better reason for confessing. Suppose Nigel 
doesn't confess but, unknown to him, Amanda does confess. Then 
Nigel ends up with the long sentence. Better than this is to 
confess and to get no more than three years: this is the safest 
(maximin) strategy. 
Amanda is in the same dilemma. The result is simple. 
When both prisoners act selfishly by confessing, they both end up 
in position D with relatively long prison terms. Only when they 
collude will they end up in position A with relatively short prison 
terms, the best combined solution. 
Of course the police know this and will do their best to 
prevent any collusion. They will keep Nigel and Amanda in 
separate cells and try to persuade each of them that the other is 
bound to confess.