The Economy as a Prisoner’s Dilemma

The current economic crisis can be modeled as an iterated (multi round) prisoner’s dilemma between firms and consumers:

 

 

Business

 

 

Keep Workers

Layoff Workers

Consumers

Buy

7,7

1,10

Don’t  Buy

10,1

3,3

 

In the chart above, 1 is the worst outcome and 10 is the best outcome. The best mutual outcome is for consumers to keep buying merchandise and for firms not to layoff workers (this is economic growth). However, individually, if consumers think they may get laid off, not get bonuses, or not get a salary raise, they will stop buying things. This will be better for them in the short run as the worst outcome is for them to keep buying things and then get laid off, but the same “saving money” behavior will hurt them in the next round of this model, when firms lay off workers. The reverse is true as well, where a firm would benefit by “trimming the fat” even if its competitors keep their workers for the first round, but if all firms lay people off, consumers will stop spending (they won’t have jobs) and more layoffs will be necessary as purchasing power drops.

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