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Microeconomics II: Game Theory and Its Applications
Microeconomics II: Game Theory and Its Applications
The rules: specifies the order of players’ decisions, their feasible decisions at each decision point (action) at each
decision point.
e.g. different pieces in chess has different moves and at any given point, a subset of the moves are available to
choose from. The players alternate in moving pieces on the game board.
𝐼 = {𝐴, 𝐵}
Actions: Confess and Deny
Row player (Adam)’s payoff is the first entry, column player’s (Bob’s) is the second one
Rule of the game: simultaneous move
Representation of Games
Normal Form Games
A strategy is a complete contingent plan for a player in the game
In the normal form representation, a game is a tuple:
𝐺 = (𝐼, 𝑆, 𝑢)
Where I= set of players i=1,2,..,n
For each player i, the set of pure strategies (actions) available is: 𝑆𝑖 , a particular strategy from this
set is 𝑠𝑖
Then, 𝑆 = 𝑆1 ∗ 𝑆2 ∗ ⋯ ∗ 𝑆𝑛 is the strategy profile for all the players
𝑠−𝑖 = (𝑠1 , 𝑠2 , … . 𝑠𝑖−1 , 𝑠𝑖+1 , … 𝑠𝑛 )
Normal Form Representation of
Example 3
Adam\Bob Deny Confess
Deny -1,-1 -3,0
Confess 0,-3 -2,-2
𝐼 = {𝐴, 𝐵}
𝑃𝑢𝑟𝑒 𝑠𝑡𝑟𝑎𝑡𝑒𝑔𝑖𝑒𝑠: 𝑆𝐴 = 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐷𝑒𝑛𝑦 ; 𝑆𝐵 = 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐷𝑒𝑛𝑦
𝑆𝑡𝑟𝑎𝑡𝑒𝑔𝑦 𝑃𝑟𝑜𝑓𝑖𝑙𝑒: 𝑆 = 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐷𝑒𝑛𝑦 , 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐶𝑜𝑛𝑓𝑒𝑠𝑠 , 𝐷𝑒𝑛𝑦, 𝐶𝑜𝑛𝑓𝑒𝑠𝑠 , 𝐷𝑒𝑛𝑦, 𝐷𝑒𝑛𝑦
𝑠𝐴 = 𝐶𝑜𝑛𝑓𝑒𝑠𝑠; 𝑠−𝐴 = 𝑠𝐵
Row player (Adam)’s payoff is the first entry, column player’s (Bob’s) is the second one
Rule of the game: simultaneous move
Representation of Games
Normal Form Games
In the normal form representation, a game is a tuple:
𝐺 = (𝐼, 𝑆, 𝑢)
Where I= set of players i=1,2,..,n
For each player i, the set of pure strategies (actions) available is: 𝑆𝑖 , a particular strategy from this
set is 𝑠𝑖
Then, 𝑆 = 𝑆1 ∗ 𝑆2 ∗ ⋯ ∗ 𝑆𝑛 is the strategy profile for all the players
For each player i, the payoff function is 𝑢𝑖 : 𝑆 → 𝑅
Payoffs are interdependent. If player i takes strategy 𝑠𝑖 and other players take strategy 𝑠−𝑖 , the
payoff to player i is: 𝑢𝑖 = 𝑢𝑖 (𝑠𝑖 , 𝑠−𝑖 )
𝑠−𝑖 = (𝑠1 , 𝑠2 , … . 𝑠𝑖−1 , 𝑠𝑖+1 , … 𝑠𝑛 )
Then, u = (𝑢1 , 𝑢2 , … , 𝑢𝑛 ) is the set of all payoffs
Normal Form Representation of
Example 3: Prisoners’ Dilemma
Adam\Bob Deny Confess
Deny -1,-1 -3,0
Confess 0,-3 -2,-2
𝐼 = {𝐴, 𝐵}
𝑃𝑢𝑟𝑒 𝑠𝑡𝑟𝑎𝑡𝑒𝑔𝑖𝑒𝑠: 𝑆𝐴 = 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐷𝑒𝑛𝑦 ; 𝑆𝐵 = 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐷𝑒𝑛𝑦
𝑆𝑡𝑟𝑎𝑡𝑒𝑔𝑦 𝑃𝑟𝑜𝑓𝑖𝑙𝑒: 𝑆 = 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐷𝑒𝑛𝑦 , 𝐶𝑜𝑛𝑓𝑒𝑠𝑠, 𝐶𝑜𝑛𝑓𝑒𝑠𝑠 , 𝐷𝑒𝑛𝑦, 𝐶𝑜𝑛𝑓𝑒𝑠𝑠 , 𝐷𝑒𝑛𝑦, 𝐷𝑒𝑛𝑦
P𝑎𝑦𝑜𝑓𝑓 𝑓𝑢𝑛𝑐𝑡𝑖𝑜𝑛𝑠:
𝑢𝐴 𝐶, 𝐶 = −2; 𝑢𝐴 𝐶, 𝐷 = 0; 𝑢𝐴 𝐷, 𝐶 = −3; 𝑢𝐴 𝐷, 𝐷 = −1
𝑢𝐵 𝐶, 𝐶 = −2; 𝑢𝐵 𝐶, 𝐷 = −3; 𝑢𝐵 𝐷, 𝐶 = 0; 𝑢𝐵 𝐷, 𝐷 = −1
Game: 𝐺 = (𝐼, 𝑆, 𝑢)
If S is finite, we can use a matrix to represent the game G
Example
2 players (1 and 2) playing Rock, Paper, Scissors
Rock wins over scissors, scissors wins over paper, paper wins over rock, otherwise draw.
Winner gets 1, draw gets 0, loser gets -1.
I=?
Example
2 players (1 and 2) playing Rock, Paper, Scissors
Rock wins over scissors, scissors wins over paper, paper wins over rock, otherwise draw.
Winner gets 1, draw gets 0, loser gets -1.
I = {1,2}
𝑆1 =?
S= ?
Example
2 players (1 and 2) playing Rock, Paper, Scissors
Rock wins over scissors, scissors wins over paper, paper wins over rock, otherwise draw.
Winner gets 1, draw gets 0, loser gets -1.
I = {1,2}
𝑆1 = 𝑅, 𝑃, 𝐶 = 𝑆2
S={RR, RP, RC, PR, PP, PC, CR, CP, CC}
𝑢1 𝑠 = 𝑅𝑅 = 0; 𝑢1 𝑠 = 𝑅𝑃 = −1, 𝑢1 𝑠 = 𝑅𝐶 = 1, … .
1\2 R P C
R 0,0 -1,1 1,-1
P 1,-1 0,0 -1,1
C -1,1 1,-1 0,0
Assumptions
Common Knowledge: For each player i, G is known.
Rationality: Each player i tries to maximize ui given what he/she thinks the others will do.
Common Knowledge of Rationality: Each player i knows that other players are rational, and that
the other players know that i is rational, and that i knows they are rational, and so on…
Exercise
Represent example 1 in the normal form.
Some Classic Games:
Matching Pennies
Two players simultaneously and independently select “heads” or “tails” by each uncovering a
penny in his hand.
If their selections match, then player 2 must give his penny to player 1; otherwise, player 1 gives
his penny to player 2.
Coordination Game
Both players obtain a positive payoff if they select the same strategy; otherwise they get nothing.
Stag Hunt Game
“Pareto coordination” game or Stag Hunt Game: Two players go hunting. They can try to hunt a
stag (strategy A), or they can look for a hare (strategy B).
If both try to hunt a stag (both choose strategy A), only then they can hunt it, in which case they
get larger share of meat. If one person looks for a stag and another looks for a hare, then they can
catch neither, and get 0. If both hunt a hare (both strategy B) then they can catch it but get a lower
share of meat.
Battle of Sexes
Two friends have to decide whether to see a movie or go to the opera.
Unfortunately, they work in different parts of the city and, owing to a massive outage of the
telephone system, find themselves incommunicado.
They must simultaneously and independently select an event to attend.
There is only one movie theater and only one opera venue, so the friends will meet each other if
they manage to coordinate their decisions.
Both prefer to be together, regardless of which event they attend.
However, player 1 prefers the opera and player 2 prefers the movie
Battle of Sexes
Two friends simultaneously and independently select an event to attend.
Both prefer to be together, regardless of which event
they attend.
However, player 1 prefers the opera and player 2 prefers
the movie
Hawk And Dove/ Chicken
Two players drive cars toward each other at top speed.
Just before they reach each other, each chooses between maintaining course (H) and swerving
(D).
If both swerve, they both save face and are satisfied.
If only one swerves, then he is proved to be a wimp, whereas the other is lauded as a tough guy
with steely nerves.
If both maintain course, they crash and are severely injured.
Next Class
Extensive Form Games
Mixed Strategies and Expected Payoffs