Coordination and Social Welfare 101

are pictured in Figure 8.2. Player 1’s best response function is

BR 1 (y) = 1 + cy,

where y is the expected value of player 1’s belief about player 2’s strategy.
Player 2’s best-response function is
BR 2 (x) = 1 + cx,

where x is the mean of player 2’s belief.

A Nash equilibrium for this game is a strategy profile (x*, y*) with the
property that
x* ∈ BR 1 (y*)  and  y* ∈ BR 2 (x*).

Because we consider BR1 and BR2 to be functions in this example, this property
can be expressed as
x* = BR 1 (y*)  and  y* = BR 2 (x*).

That is, the point (x*, y*) should lie on the best-response functions of both
players. There is one such point and it is obviously located where the two best-
response functions cross. We can compute this point by solving the following
system of equations:
x* = 1 + cy*  and  y* = 1 + cx*.

Substituting the second equation into the first yields x* = 1 + c(1 + cx*),
which simplifies to x*(1 − c 2) = 1 + c. Noting that 1 − c 2 = (1 + c)(1 − c),
we therefore have x* = 1>(1 − c). Substituting this equation into the second
equation yields y* = 1>(1 − c). Observe that this strategy profile is the same as
that computed in Chapter 8. In this game, rationalizability and Nash equilibrium
predict the same, single strategy profile.

Coordination and Social Welfare

We observed earlier that rationalizability does not necessarily imply coordi-

nated behavior by the players. Nash equilibrium, on the other hand, implies
some coordination because it embodies a notion of congruity for a single strat-
egy profile. However, Nash equilibria do not always entail strategies that are
preferred by the players as a group. For instance, the only Nash equilibrium of
the prisoners’ dilemma is inefficient, in that both players would be better off if
they played differently. Thus, we note the prisoners’ dilemma as an example of
individual incentives interfering with the interests of the group.

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 102 9: Nash Equilibrium

Sometimes a socially inefficient outcome prevails not because of conflict

between individual incentives but because there is more than one way to coor-
dinate. Consider the Pareto coordination game in Figure 9.1. This game has two
Nash equilibria on which the players may coordinate. The equilibrium (B, B)
is inefficient; both players would rather be in the (A, A) equilibrium than in
the (B, B) one. But (B, B) is an equilibrium nonetheless. Given that the other
chooses strategy B, each player’s only rational move is to select B as well.
Lest you think that inefficient equilibria should be ruled out in practice,
consider some examples of inefficient equilibria in the world—which, one
might argue, are more the rule than the exception. The most well-known
historical example is the layout of most computer keyboards and typewriters
in the English-speaking world. The standard arrangement of keys (starting with
QWERTY in the third row) was devised many years ago by the founder of
the typewriter to minimize “jamming” of the keys. On mechanical typewrit-
ers, this problem is created when adjacent keys are pushed at nearby points of
time, causing the associated arms that strike the ribbon to tangle. The inventor
arranged the keys so that those that are likely to be used in close proximity (such
as “a” and “n”) are not adjacent on the keyboard.
Unfortunately, many people believe the QWERTY keyboard is not the most
efficient layout for speedy typing. Furthermore, “jamming” is not a problem
with modern typewriters and computers. In the 1930s, August Dvorak and
William Dealey, through a careful study of word usage in the English language,
devised another keyboard layout that is commonly referred to as the Dvorak
keyboard. Some people assert that those who learn to type with this keyboard
can do so at rates substantially higher than is possible with QWERTY.2 We thus
must ask the economic question: Why is the QWERTY keyboard still the norm?
The answer is that QWERTY is entrenched and few people have the incen-
tive to switch to a new format, given that most others in the world use QWERTY.
In the Pareto coordination game of Figure 9.1, think of player 1 as the typical
computer owner and player 2 as the typical computer manufacturer. Strategy
A is to buy or produce a Dvorak keyboard, and strategy B is to buy or produce
the QWERTY keyboard. If most people in the world are trained to use only the
QWERTY design—that is, they have adopted strategy B—it is obviously best
for a computer maker to build QWERTY keyboards. Furthermore, because most
computer keyboards in existence are QWERTY, the typical youngster will be
advised to practice on QWERTY rather than Dvorak, and the next generation
2
A woman named Barbara Blackburn has been cited in the Guinness Book of World Records as the fastest
typist in the world. She typed at a comfortable 170 words per minute by using the Dvorak system, with a
top speed of 212. You can, too, by converting your computer keyboard to the Dvorak layout, which merely
requires a minor alteration of software. Of late, some have argued that the advantage of the Dvorak keyboard
is actually quite minor, but it still makes for a good example.

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 Coordination and Social Welfare 103

of computer buyers will demand QWERTY keyboards. Given that the English-
speaking world began typing with QWERTY, the Dvorak keyboard has little
chance of widespread success. Besides, computerized speech recognition may
make the keyboard obsolete, at which time the QWERTY-Dvorak debate will be
relegated to history books. I am proud to note that part subs this textbook were
gem elated using speech recognition software.
The competition between VHS and Betamax videotape formats during the
1980s is another good example. Many people regarded the Betamax format
as superior in the quality of reproduction, yet this format died out. Its demise
may be the simple result of random factors in the early VCR market or shrewd
marketing by VHS producers. There was a time in which both formats were
popular, although it was obvious that efficiency would be enhanced if every-
one used the same format. Gradually, VHS gained a greater market share. At
some point, the VHS movement picked up steam and decisively moved toward
domination, as new video buyers rationally flocked to the format that appeared
to be taking hold. A similar competition briefly occurred in the market for high-
definition video storage between Blu-Ray and HD-DVD discs. However, in this
case the manufacturers quickly recognized the looming inefficiency of a failure
to coordinate, and they agreed to retire the HD-DVD standard in favor of Blu-
Ray. The question of which is the better technology is probably not relevant at
this point, for the world is rapidly moving to solid-state and cloud data storage.
As a final example, consider cigarette lighters in automobiles. Years ago,
when there were no cell phones or automobile refrigerator units, auto manu-
facturers installed round cigarette lighters in dashboards. Many people smoked
while driving and they appreciated the little device that, when pressed, allowed
the flow of electricity to pass through a resistant wire coil, creating heat suffi-
cient to light a cigarette. Then came the electronic age and the flow of electronic
gadgets to market. Manufacturers of cell phones—and other devices—realized
that folks would like to use their phones while driving (which is ill advised
because cell phone use while driving is on a par with drunkenness in its contri-
bution to traffic accidents and is illegal in some states). These manufacturers
discovered that they could power the phones by using an adapter that fits into a
cigarette lighter, and so they included the adapter in their designs.
Unfortunately, automobile cigarette lighters do not provide the most secure
electrical connection. The flow of electricity is easily disrupted by bumps in the
road, as my wife and I discovered on a long camping trip for which we brought
a portable refrigerator—okay, we should have been “roughing it” anyway. There
are better, more reliable ways of getting electricity to devices; more secure plug
and socket connections can easily be implemented. But the auto producers and
the device manufacturers are in an inefficiently coordinated outcome, from
which neither side has a unilateral incentive to deviate. Automobile companies

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 104 9: Nash Equilibrium

could, at a reasonable cost, design and install more secure electrical sockets
in their cars, but they have no incentive to do so if the device manufacturers
are using cigarette lighter adapters. Further, the device manufacturers have no
incentive to adopt a different plug if automobile companies do not install the
new sockets. Perhaps USB ports will rescue society from this inefficient coordi-
nation, at least for the use of low-power devices.

The Third Strategic Tension

The QWERTY, VHS–Betamax, and auto examples are just a few of the ways
in which our world has coordinated inefficiently. It might be helpful for you to
look for more examples. On a thematic level, note that inefficient coordination
poses a problem even if the players have the same preferences over outcomes
and there is no strategic uncertainty—that is, even if the players entirely eschew
the first and second strategic tensions.3 Thus, the specter of inefficient coordina-
tion is called the third strategic tension. You might start to contemplate whether
specific social or economic institutions can alleviate this tension as they might
alleviate strategic uncertainty (the second tension) in the real world. Further-
more, you can ruminate over how institutions help select between equilibria
in games such as the battle of the sexes, where players disagree about which
equilibrium is preferred.
Because the terms “joint” and “social” come up frequently in the context
of optimality and efficiency, some clarification is in order. When using these
terms, we should always make clear which set of people we are focusing on. For
example, we might say that two firms realize their joint optimal strategy profile;
in this case, we are addressing only the firms’ welfare, not the utility of other
agents in the world (such as the firms’ customers). In fact, an outcome that is
jointly efficient from the firms’ standpoint may be quite inefficient with respect
to a larger set of actors. Generally, when I use the terms “joint” and “social,”
either (1) I will have specified the group or society of interest or (2) I will be
referring to the entire set of players in the game at hand.

Congruous Sets

Remember that the Nash equilibrium concept represents the extreme version of
congruity in which the players coordinate on a single strategy profile. In some
settings, it may not be reasonable to expect such an extreme form of coordi-
nation. One reason is that there may not be a social institution that serves to
3
Recall that the first two tensions are (1) the clash between individual and group incentives and (2) strategic
uncertainty and its implications for joint optimality.

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