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Factors affecting Prisoner's Dilemma By Manoj Kumar (07HS2021) IIT Kharagpur

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Abstract: This paper looks into the prisoners dilemma situation and it briefly introduces us to the situation where a player has to opt for either a dominant strategy or co-operative behavior. This paper discusses a few factors which might motivate someone to choose a particular strategy. Three general situations have been considered for discussion of these strategies which are that of the general prisoners dilemma, that of the duopoly market and that of typical human behavior student co-operation in the field of study. Several factors determine which of the 2 strategies the dominant strategy or the co-operative strategy will be used by the players in the context of the 3 situations and they are (i) Frequency of the games, No. of games and the Visibility of the players, (ii) An increase in the no. of players with and without mutual interaction, and, (iii) Difference in the payoffs for the players. Two practical examples have been taken up to further show the relevance of some of these factors; one is that of oligopolistic co-operation in the water industry and the other is that of Diaper Wars. Problem Definition: One usually comes across several situations where some individual(s) are required to choose between a dominant strategy (when one strategy is better than another strategy for one player, no matter how that player's opponents may play) or a co-operative strategy (it is one where the players are able to form binding commitments). It is not very clear when one should apply the dominant strategy and when one should apply the co-operative strategy if one is not very clear how they work. This paper solves this problem and gives a very picture when one should apply each strategy in various situations. Solution of the Problem Defined: The most common situation is that of prisoners dilemma (example 1). The table 1 below shows the payoff matrix for the same. Prisoner B Confess Dont Confess Confess Dont Confess -5, -5 -1,-10 -10,-1 -2,-2 Table 1 Prisoner A

By the dominant strategy both prisoners confess and both get 5 years in prison. Even though it is a Nash equilibrium it is not a strong one. Both shall have a higher payoff if they move to Dont Confess, Dont Confess. 2nd example is from the duopoly market. For 2 firms, Firm A and Firm B the payoff matrix is as given. Firm 2 Firm 1 Low Price High Price Low Price High Price 20,20 100,-50 -50,100 60,60

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Table 2 If both the firms charge higher price both will be able to make higher profits than if both charged a lower price (which is by the dominant strategy). By the latter case both will make lower profits. The former case is Nash equilibrium but not a strong one, because if both charge a higher price then both enjoy higher profits. However either of the firms will not charge a higher price because he will lose money if its competitor charges a lower price. But in the repeated game any one should think about strategy: I start out with a high price, which I maintain so long as my competitor continues to co-operate and also charge a high price. As soon as my competitor lowers his price, However, I follow suit and lower mine. If my competitor later decides to co-operate and raise his price again, Ill immediately raise my price as well. Therefore both of them afraid to sets a low price & undercuts his competitor. However in that month he will make a large profit. But he knows the following his competitor will set a low price. So that his profit will fall & will remain low as long as both of them continue to charge a low price. 3rd example is from human behavior student co-operation in the field of study. There is a student Ram who must decide if he should co-operate or not. If he co-operates with someone and that person doesnt then Ram is going to be in loss because his time, energy and money consume and he gets very little knowledge in the bargain. If both co-operate then both obtain good profit because they get useful knowledge out of it. If neither co-operates then they dont lose anything because it doesnt consume time and money. The Payoff matrix is shown below: Other one Co-operate Co-operate 10,10 Doesnt Co-operate 15,-5 Table 3 The dominant strategy is (doesnt co-operate, doesnt co-operate). But it is not a strong Nash equilibrium point because if both of them behave co-operatively both will be in profit. Now we come to the factors which determine which strategy is to be chosen. 1. Frequency, no. of games and visibility:-In the 1st example one cant choose between the two strategies since prisoners may have only one opportunity to confess. He will prefer to apply dominant strategy and confess. Here frequency and no. of game play an important role. In the 2nd example the situation is one of repeated games and every firm wants to maximize its profit not only in the present period but in the future also. Here firm one knows that if he sets a low price and firm two sets a high price then next time then other firm will also set a low price and both will lose their profits. As the no. of games increases the motivation to behave cooperatively and not dominantly will increase. Doesnt Co-operate -5,15 0,0 Ram

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Ifm both firms decide price once a year then firm one thinks that if it charges a high price and firm w o om w. A Y.c two charges a low price then the latter dominates for the whole year and vice-versa. However B B Y if firm 1 sets low price and suppose firm 2 sets higher price then the next year firm 1 is not so motivated to repeat the mistake because frequency is very low and so visibility is also low. If this period reduces to a month or a week then either of the firms will not be scared of being dominated for the whole period and its motivation to set a high price will increase with the period getting smaller. This is because with the smaller period the firm can take more risks since it knows that the other firm is also rational. It knows that if it sets the low price in this period then it will be forced to earn lower profit because the next time the other firm will not set the higher price. However in the next period both can set higher price and enjoy greater profits. In the 3rd example of student co-operation, visibility is very high. Ram is able to know whether the other student is co-operative or not. This can lead to higher profits if both co-operate. As frequency is also high, Ram can change his behavior at any point of time. So there is no risk to take the strategy for higher payoff. For example (referring to the number of games), in IPL there were about 100 cricketers for which auction was organized. In this way, here the number of games (number of auctions) was quite large. So if any franchise had moved 1st and had strongly decided to buy any particular player then other franchises would have known this and would have co-operated like in the case of Ricky Ponting. His auction price was deemed too low despite his significant stature in cricket. Referring to visibility, in Diaper Wars between Kimberly-Clark and P&G the visibility of R&D is quite low so they behave dominantly and they went for investment in R&D. 2a. Increase in the no. of players (with mutual interaction) :- Let us assume that the no. of prisoners increases to 3 in the first example and the payoff matrix is as shown For Prisoner C confessing Prisoner B Confess Dont Confess Confess Dont Confess -5, -5,-5 -1,-15,-1 -15,-1,-1 -10,-1,-10 Table 4a Prisoner A
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For Prisoner C not confessing Prisoner B Confess Dont Confess Confess -1, -1,-15 -1,-10,-10 Dont Confess -10,-1,-10 -2,-2,-2 Table 4b Prisoner A

Here everybody prefers to confess by dominant strategy. Motivation to adopt the dominant strategy stronger than the case of two prisoners because here the no. of players increases and the risk for better situation is high which is demotivating factor.

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The oligopoly situation is like the duopoly situation of 2nd example and bears a resemblance to w om om w. A Y.c the previous example. The no. of the players for the same product increases then the risk is also B B Y high which demotivates them to go for higher payoff.
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Mathematical Interpretation: Let the probability of certainty of other player be a; 0<a<1 (let a be fixed) and number of player in the game is (x+1). So total certainty is ax. The chance of certainty is equal to the co-operative factor and 1 minus that is equal to the dominant factor. So function f(x) = ax; for co-operation. f(x) = ln(a)*ax ; f(x) is -ve for 0<a<1. f(x) = ln(a)*ln(a)*ax ; f(x) is +ve for 0<a<1.

Graph of ax, where 0<a<1. Note that f(x) tends to 0 as x tends to infinity.

And function f(x) = 1 - ax; for dominance. f(x) = -ln(a)*ax ; f(x) is +ve for 0<a<1. f(x) = -ln(a)*ln(a)*ax; f(x) is -ve for 0<a<1.

Graph of 1-ax, where 0<a<1. Note that f(x) tends to 1 as x tends to infinity.

So with the increase in the number of players, dominant factor will increase with decreasing rate and co-operate behavior will decrease. And if number of players is very large then probability of dominance tends to one and probability of co-operation tends to zero. This situation occurs in perfect competitive market and sellers sell at low price according to dominant factor. When the number of players is one then this is the situation of monopoly and he sets high prices as in the situation of co-operation. These two practical situations prove this mathematical interpretation.

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2b. Increase in the no. of players (without mutual interaction):- In the prisoners dilemma w om om w. A Y.c example if prisoner A interacts with several prisoners B, C, D and other prisoners also interact B B Y with all others then they would be motivated to get better payoff than use dominant strategy. This is like a repeated game because everyone has his reputation and everyone is afraid to cheat.
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In the 2nd example firm one competes with firm 2 for goods M, with firm 3 for goods N, with firm 4 for goods O. Firm 2 competes with firm 3 for goods X and with firm 4 for goods Y and so on. Then firm 1 will go for that strategy in which it will be in better situation. Suppose firm 1 & 3 and 1 & 4 co-operate for goods N and O respectively and firm 2 doesnt. Then firms 1, 3 & 4 are in better situation and firm 2 isnt. This will motivate firm 2 to co-operate. In 3rd example Ram is preparing for GMAT exam and he interacts with several people. If want to place himself in better situation then he would help other students so that they would also help him. In this way he will get big benefits. 3. Difference in payoffs: - Suppose the matrix for the 1st example is Prisoner B Confess Dont Confess Confess Dont Confess -5, -5 -1,-10 -10,-1 -2,-2 Table 5 Prisoner A

For any of the prisoners confessing is the dominant strategy and (confess, confess) is the Nash equilibrium. If the difference in the payoffs of (confess, confess) and (dont confess, confess) increases then this will motivate A to use dominant strategy. He may not go for the strategy which gives the better payoff because of the high pay difference since the other prisoner may not co-operate. Conversely if pay difference is low then he can manage it and he will be less motivated to use the dominant strategy. If the difference in the payoffs of dominant and better situation increases then this would motivate the prisoners to go for better situation since they know there is no game without risk. In this situation the gain is high and risk is low so they go for higher risk and better gain. This is same for the other examples also. Example 4: Diaper Wars For more than a decade, Rs. 4 billion-per-year disposable diaper industry in the United States has been dominated by 2 firms Procter and Gamble with an approximately 50-60% market share and Kimberly Clark with another 30%. In this market if a firm can shave its production cost even slightly, it can reduce price and capture market share. As a result both firms are forced to spend heavily on research and development (R&D) in a race to reduce cost. Competing through R&D Kimberly-Clark

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P&G

R&D No R&D R&D 40, 20 80, -20 No R&D -20, 60 60, 40 Table 6

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This is the payoff matrix. By observing carefully we come to know that the 2 firms are in Prisoners Dilemma: spending money on R&D in a dominant strategy for each firm. But why hasnt co-operative behavior evolved? After all, the 2 firms have been competing in this market for years and the demand for diapers is fairly stable. For several reasons. 1st, it is difficult for a firm to monitor its competitors R&D activities the way it can monitor price. 2nd, it can several years to complete an R&D program that leads to a major product improvement. As a result, tit-for-tat strategy in which both firms co-operate until one of them cheats are less likely to work. A firm may not find out that its competitor has been secretly doing R&D until the competitor announces a new and improved product. By then it may be too late to gear up an R&D program of its own. An Entrant would have to spend a considerable amount on R&D (besides building new factories) to capture even a small share of the market after it began producing a new firm would have to continue to spend heavily on R&D to reduce its costs over time. Entry could be profitable only if P&G and Kimberly-Clark stop doing R&D. So that the entrant could catch up and eventually gain a cost advantage. Butno rational firm would expect this to happen.
(Example 4 has been taken from Microeconomic Theory by Pindyck, Rubinfeld and Mehta: Chapter 12, Game Theory and Competitive Strategy. Originally it has been taken from Example 14.3 in Chapter 14 which examines in more detail the profitability of capital investment by a new entrant in the diaper market).

Both firms spend heavily on R&D using dominant strategies and not co-operative behavior because of difficulty in monitoring, time loss (if any one cheats, risks involved) and deterrence to new entry. Example 5: Oligopolistic co-operation in the water meter industry For more than 30 years almost all the water meters sold in the United States has been produced by 4 American companies: Rockwell International, Badger Meter, Neptune Water Meter Company and Hersey Products. Rockwell has had about 35% share of the market and other 3 firms have together had about a 50-55% share. The cost of meters is a small part of the total cost of providing water; utilities are concerned mainly that the meters be accurate and reliable. Demand is very inelastic in nature. With inelastic and stable demand and very little threat of entry by new firm (due to relationship of buyers with suppliers and huge investment in a large factory for new entrants), the existing 4 firms could earn substantial monopoly profit if they set prices co-operatively otherwise profits would fall to nearly competitive levels so this is also a situation of Prisoners Dilemma. Co-operation has prevailed. Same 4 firms have been playing repeated games for decades. Demand has been stable and predictable over the years. The firms have been able to assess their own and each others costs. Each firm co-operates as long as its competitors are cooperating.

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(Example5 has been taken from Microeconomic Theory by Pindyck, Rubinfeld and Mehta: Chapter 12, Game Theory and w om Competitive Strategy. This example is based in part on Nancy Taubenslag, Rockwell International, Harvard Business School Casew . A B B Y Y . c o m No. 9-383-019, July 1983. In 1979, Neptune Water Meter Company was acquired by Wheelabrator-Frye. Hersey Products is a small privately held company.)

In this situation, visibility is too high and so they are able to reset their price without the loss of too much time. Plus they are not afraid of new entrants so co-operation is followed and not the strategy of domination. Results and Discussion: Dominant strategy in the prisoners dilemma is not a strong equilibrium point. Various factors: number of players with/without mutual interaction, difference in payoffs, visibility, frequency, number of games, possibility of new entrants, recovery and demand curve simultaneously decide which one is an equilibrium point - dominant strategy or one of cooperation, which have been thoroughly discussed in the paper. One or more these factors may simultaneously be at work. Practical Application: We have already seen several instances where individuals face situations where they have to decide between either of the situations. Other instances can be duopolistic and oligopolistic industries of all kinds, the stock market, the lottery industry, any kind of financial market where risk is involved, the playing arena (in any kind of sports) and several other examples from everyday life. It is inconceivable to imagine a life without applying any of these strategies. Reference: Pindyck, Rubinfeld and Mehta [2004], Game Theory and Competitive Strategy Microeconomic Theory, Chapter 12.

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