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Leonardo Felli

NAB.2.14

16 January 2014

Course Outline

Purification of Mixed Strategy.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 2 / 28

Course Outline (contd)

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 3 / 28

Admin

I Office Hours:

I Monday 13:00-14:00, Thursday 11:00-12:30

I or by appointment (e-mail lfelli@econ.lse.ac.uk).

http://econ.lse.ac.uk/staff/lfelli/teaching

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 4 / 28

References:

Harvester-Wheatsheaf, 1992.

Oxford University Press, 2009.

Princeton University Press, 2013.

Cambridge: The MIT Press, 2nd Edition, 2005.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 5 / 28

Static Bayesian Games: Example 1.

1\2 L R

U 1, 1 0, 0

D 0, 0 6, 6

This game has two pure strategy Nash equilibria (U, L) and (D, R)

with payoffs respectively (1, 1) and (6, 6).

There also exists one mixed strategy Nash equilibrium (6/7, 6/7)

with payoffs (6/7, 6/7).

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 6 / 28

Static Bayesian Games: Example 1 (contd)

Assume now that player 2 has some small uncertainty when

casting her choice of strategy in the game.

9

With probability she thinks she is playing Game A:

10

1\2 L R

U1 1, 1 0, 0

D1 0, 0 6, 6

1

while with probability she thinks she is playing Game B:

10

1\2 L R

U2 1, 0 0, 10

D2 0, 0 6, 6

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 7 / 28

Static Bayesian Games: Example 1 (contd)

We assume that:

after she has decided her strategy;

game he is playing.

the outcome of this game.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 8 / 28

Static Bayesian Games: Example 1 (contd)

be the basic tool to get a prediction.

In particular we can determine the strategy choice of player 1 as a

function of what he expects player 2 to do as best reply:

player 2 to play L is U1 , while his best reply if he expects

player 2 to play R is D1 .

player 2 to play L is U2 , while his best reply if he expects

player 2 to play R is D2 .

This is not a surprise since the payoffs to player 1 are the same in

both games.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 9 / 28

Static Bayesian Games: Example 1 (contd)

payoffs are not enough.

is played.

I with probability 1/10 the game played is B.

given her beliefs on which game is played.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 10 / 28

Static Bayesian Games: Example 1 (contd)

are:

9 1 9

2 (U1 , U2 ; L) = 1 +0 =

10 10 10

9 1

2 (U1 , U2 ; R) = 0 + 10 =1

10 10

The best reply is therefore R.

are:

9 1

2 (D1 , D2 , L) = 0 +0 =0

10 10

9 1

2 (D1 , D2 , R) = 6 +6 =6

10 10

The best reply is therefore R.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 11 / 28

Static Bayesian Games: Example 1 (contd)

If player 2 expects player 1 to play U1 or D2 her expected payoffs

are:

9 1 9

2 (U1 , D2 ; L) = 1 +0 =

10 10 10

9 1 6

2 (U1 , D2 , R) = 0 +6 =

10 10 10

The best reply is therefore L.

Finally if player 2 expects player 1 to play D1 or U2 her expected

payoffs are:

9 1

2 (D1 , U2 ; L) = 0 +0 =0

10 10

9 1 64

2 (D1 , U2 , R) = 6 + 10 =

10 10 10

The best reply is therefore R.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 12 / 28

Static Bayesian Games: Example 1 (contd)

the players given player 2s beliefs on which game is played.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 13 / 28

Static Bayesian Games: Cournot Duopoly

information.

c(q1 ) = c q1 .

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 14 / 28

Static Bayesian Games: Cournot Duopoly (contd)

We assume that:

Firm 1 does not know the variable cost of firm 2 but believes that:

1

I with probability the cost is high cH ,

2

1

I with probability the cost is low cL .

2

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 15 / 28

Static Bayesian Games: Cournot Duopoly (contd)

P(q1 + q2 ) = a (q1 + q2 )

where cH < a.

whether its cost is high or low.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 16 / 28

Static Bayesian Games: Cournot Duopoly (contd)

h i

H2 (q ,

1 2q H

) = q2

H

a (q 1 + q H

2 ) cH

or h i

L2 (q1 , q2L ) = q2L a (q1 + q2L ) cL

1 h i

1 (q1 , q2H , q2L ) = q1 a (q1 + q2H ) c +

2

1 h i

+ q1 a (q1 + q2L ) c

2

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 17 / 28

Static Bayesian Games: Cournot Duopoly (contd)

For any given quantity chosen by firm 1, q1 , firm 2s best reply is,

depending on the value of the cost:

h i

max q2H a (q1 + q2H ) cH

q2H R+

or

1

q2H = (a q1 cH ) ,

2

and h i

max q2L a (q1 + q2L ) cL

q2L R+

or

1

q2L = (a q1 cL ) .

2

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 18 / 28

Static Bayesian Games: Cournot Duopoly (contd)

For any given quantity chosen by the two types of firm 2 q2H and

q2L , firm 1s best reply is:

1 h i 1 h i

max q1 a (q1 + q2H ) c + q1 a (q1 + q2L ) c

q1 R+ 2 2

or

1 1 H

1

L

q1 = a q2 c + a q2 c .

2 2 2

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 19 / 28

Static Bayesian Games: Cournot Duopoly (contd)

In other words the best reply of the two types of firm 2 and of firm

1 are:

1

q2H = (a q1 cH ) ,

2

1

q2L = (a q1 cL ) ,

2

1 1 1

q1 = a q2H c + a q2L c .

2 2 2

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 20 / 28

Static Bayesian Games: Cournot Duopoly (contd)

(a 2c + 12 cH + 12 cL )

q1 =

3

and

(a 2cH + c) 1

q2H = + (cH cL )

3 12

and

(a 2cL + c) 1

q2L = (cH cL )

3 12

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 21 / 28

Static Bayesian Games: Cournot Duopoly (contd)

with asymmetric information.

with perfect information.

that firm 1 knows the costs of firm 2.

on whether it is competing with the high cost firm 2, q1H , or the

low cost firm 2, q1L .

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 22 / 28

Static Bayesian Games: Cournot Duopoly (contd)

These quantities are the solution to the following two problems:

h i

max q1H a (q1H + q2H ) c

q1H R+

1

q1H = a q2H c ,

2

and h i

max q1L a (q1L + q2L ) cL

q1L R+

or

1

q1L = a q2L c .

2

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 23 / 28

Static Bayesian Games: Cournot Duopoly (contd)

a q1H cH a q1L cL

H

q2 = , q2L = .

3 3

are then:

(a 2c + cH ) (a 2cH + c)

q1H = q2H =

3 3

and

(a 2c + cL ) (a 2cL + c)

q1L = q2L =

3 3

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 24 / 28

Static Bayesian Games: Cournot Duopoly (contd)

complete vs. asymmetric information:

(a 2cH + c) 1

q2H = + (cH cL ) > q2H

3 12

and

(a 2cL + c) 1

q2L = (cH cL ) < q2L

3 12

1 H 1 L

q1 = q + q1

2 1 2

or

q1H > q1 > q1L

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 25 / 28

Static Bayesian Game: Definition

A game of incomplete information is defined by:

I The set of players N, in the Cournot model

N = {1, 2}.

= {cH , cL }

Ai = R+ .

T1 = {c}, T2 = {cH , cL }.

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 26 / 28

Static Bayesian Game: Definition (contd)

I The believes of every player on the types of the opponent: i

a conditional probability distribution on Ti , in the Cournot

model:

1 1

1 (cH ) = , 1 (cL ) = , 2 (c) = 1.

2 2

type ui , in the Cournot model:

h i

u2 (q1 , q2H | cH ) = q2H a (q1 + q2H ) cH

h i

u2 (q1 , q2L | cL ) = q2L a (q1 + q2L ) cL

1 h i

u1 (q1 , q2H , q2L ) = q1 a (q1 + q2H ) c +

2

1 h i

+ q1 a (q1 + q2L ) c

2

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 27 / 28

Static Bayesian Game: Definition (contd)

A strategy for each player is then an action choice for any type of

the player:

si (ti ) Ai .

I player 1s strategy: q1 :

I player 2s strategy: q2 (cH ) = q2H , q2 (cL ) = q2L .

= {N, , Ai , Ti , i , ui }

Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 28 / 28

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