The Prisoner’s Dilemna demonstrates the effect of imperfect information on decisions. It can be used in teaching about imperfect markets or the effect of imperfect information on decisions in economics.
This is the prisoner’s dilemna:
Two persons are arrested for burglary and possessing stolen property. The two are put in seperate rooms and are not allowed to communicate. They are told seperately that if they both confess, they will both be sentenced for 3 years for burglary. If neither confesses they can only be convicted of the lesser crime of possessing stolen property, and will be sentenced for 1 year. If only one confesses, that prisoner will be released and the other will receive a harsher sentence of 5 years.
This result in economics is referred to ‘suboptimal equilibrium’ resulting from imperfect information and it applies in many economic situtations.