The Solution
For the sake of explanation let's label the prisoners in line order A B and C. Thus B can see A (and A's hat color) and C can see A and B.
The prisoners know that there are only two hats of each colour. So if C observes that A and B have hats of the same colour, C would deduce that his own hat is the opposite colour. However, if A and B have hats of different colours, then C can say nothing. The key is that prisoner B, after allowing an appropriate interval, and knowing what C would do, can deduce that if C says nothing the hats on A and B must be different. Being able to see A's hat he can deduce his own hat colour. (The fourth prisoner is irrelevant to the puzzle: his only purpose is to wear the fourth hat).
In common with many puzzles of this type, the solution relies on the assumption that all participants are totally rational and are intelligent enough to make the appropriate deductions.
After solving this puzzle, some insight into the nature of communication can be gained by pondering whether the meaningful silence of prisoner C violates the "No communication" rule (given that communication is usually defined as the "transfer of information").
Read more about this topic: Prisoners And Hats Puzzle
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