We have seen the prisoner’s dilemma in an older post. The rational decision-maker, the prisoner, will confess because it gives the best outcome, no regret, irrespective of what the other would do. Therefore, it is a Nash equilibrium, named after the American mathematician John Nash – the best response for the prisoner to the choice of the other.
But we know that it, {confess, confess}, is not the best result for either of the players. In other words, the outcome (Nash equilibrium) is not Pareto efficient! A Pareto efficient outcome happens when there isn’t a possible result where someone is better off and nobody is worse off. For this game, Pareto efficiency would have occurred had the prisoners cooperated. But then, confess is the dominant strategy.
Another example of a Pareto inefficient Nash equilibrium is when participants over-consume common resources in what is known as the tragedy of the commons. It is a tragedy as parties out of self-interest consume and deplete the shared resources.
