DYNAMIC GAME OF COMPLETE INFORMATION

Dynamic games of complete information are games that play sequentially. They are usually
depicted by extensive form specifying
- players,
- when each player gets to move, and
- player’s available choices and information
- payoffs after sequence of moves end.

This type of game is better explained by the following example. Suppose player 2, for example, I,
surprises player 1 (you) as you leave ATM with ฿ 40,000. I say “give me the money or I will blow
us both up!”. The game can then be depicted in a following extensive form, also known as game
trees.

Hand Over Keep money

2 2

Blow up Don’t Blow up Don’t

Player 1’s payoff ⎡ −11⎤ ⎡ −1⎤ ⎡ −10 ⎤ ⎡0⎤

⎢ −9 ⎥ ⎢ +1⎥ ⎢ −10 ⎥ ⎢0⎥
Player 2’s payoff ⎣ ⎦ ⎣ ⎦ ⎣ ⎦ ⎣ ⎦
Figure 1

The game in an extensive form has the following structures. The tree has an initial node and other
nodes. In every node, except the initial node, has predecessors. Predecessors give single path back
to the initial node. Intuitively, a node determines the entire sequence of moves to that point. The
last thing is the terminal nodes. They are not the predecessors of anything and indicate all possible
outcomes.

Dynamic games of complete information also have some nonplayers who randomly enter the game
with some positive probability. These nonplayers are called nature, or moves by nature. Nature is
neither player 1 nor player 2. Some texts denote nature by ‘player 0’. In an extensive form, it is
depicted by a hollow circle, with probabilities in parentheses. For example,

page 1
 Commit crime Don’t

(0.3) (0.7)
Get caught Not caught

Figure 2

The game of complete information does not mean the same thing as the game with perfect
information. Complete information in game theory means each player fully knows the strategies of
another. But in the dynamic game, sometimes players might not know which strategy the other
had used. We categorize these as the dynamic game with complete information and perfect
information. Examples of dynamic games with complete and perfect information are chess,
Stackelberg competition. Examples of dynamic games with complete but imperfect information are
poker, or repeated simultaneous move games. Hence the game of with complete but imperfect
information means that players know each other’s strategy but have no idea which one had been
used.

In an extensive form, the game with imperfect information can be depicted by information
sets. Since each player does not know all earlier moves, we must partition the set of player’s
decision nodes into subsets, called information set. When player i has to move, he observes
information set containing “real” node, but he may not know which node had been reached.
Consider the following Prisoner’s dilemma in an extensive form.

Collude Defect

2 2

Collude Defect Collude Defect

⎡100 ⎤ ⎡ 25 ⎤ ⎡120 ⎤ ⎡80 ⎤

⎢100 ⎥ ⎢120 ⎥ ⎢ 25 ⎥ ⎢80 ⎥
⎣ ⎦ ⎣ ⎦ ⎣ ⎦ ⎣ ⎦
Figure 3

Or sometimes people write the information set using oval as follows,

page 2
 1

Collude Defect

2 2

Collude Defect Collude Defect

⎡100 ⎤ ⎡ 25 ⎤ ⎡120 ⎤ ⎡80 ⎤

⎢100 ⎥ ⎢120 ⎥ ⎢ 25 ⎥ ⎢80 ⎥
⎣ ⎦ ⎣ ⎦ ⎣ ⎦ ⎣ ⎦
Figure 4

As you can see, in the game of perfect information, each information set contains just one node. In
the game of imperfect information, each information set can contain more than one node. Figure 3
or 4 contain two nodes. Reconsider figure 1.

Hand Over Keep money

2 2

Blow up Don’t Blow up Don’t

⎡ −11⎤ ⎡ −1⎤ ⎡ −10 ⎤ ⎡0⎤

⎢ −9 ⎥ ⎢ +1⎥ ⎢ −10 ⎥ ⎢0⎥
⎣ ⎦ ⎣ ⎦ ⎣ ⎦ ⎣ ⎦
Figure 1

Player 1 has two pure strategies, ‘Hand over’ and ‘Keep money’, which we will abbreviate
them as H and K. How many strategies does player 2 have? You may think that player 2 has two
pure strategies, ‘Blow up’ and ‘Don’t blow up’ abbreviated as B and D. However, this specification
does not account for the fact that player 2 acts differently at each information set. Therefore,
player 2 has four pure strategies. They are (BB), (BD), (DB), and (DD). The first element in the
parentheses gives player 2’s choice if player 1 chooses H, and the second element gives player 2’s
choice if player 1 chooses K. For example, (BD) means player 2 will blow both of them up if player
1 chooses H and player 2 will not blow up if player 1 chooses K. Hence, the strategy set of player 1
is {H, K} and player 2’s strategy set is {BB, BD, DB, DD}. Suppose that player 1’s strategies have
3 strategies, it is left to the readers to think how many strategies player 2 has.

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 We can write this extensive form in the strategic form of the bomb-threat game as follows.

1 2 BB BD DB DD
H -11, -9 -11, -9 -1, 1 -1, 1
K -10, -10 0,0 -10, -10 0, 0
Table 1
We are to consider the dominant strategies of each player. We see that DD weakly
dominates all other strategies of player 2, and DB weakly dominates BB. To find Nash Equilibria,
circle the payoff corresponding to the player’s best responses. There are three pure strategy Nash
Equilibria: (H, DB), (K,BD), and (K, DD). You may pause and think of these strategies for a
while. (H, DB) means that player 1 hands over the money and player 2 chooses not to blow up
while will do so if player 1 keeps money. (K, BD) means that player 1 chooses to keep money and
player 2 will blow up if player 1 hands over and will not choose to do so if player 1 keeps money.
The first of these seems reasonable but the second sounds strange. However, both strategies are off
equilibrium path. Why? Because player 2 threatens to use B in circumstances that will not
happen. Player 2’s threat to use B is not credible since player 2 is better off playing D regardless of
player 1’s choice.

We have learned in class how to find the rational choice by backward induction or
sometimes called backward recursion.

1
Consider 2’s left node. 2 thinks that if 1
H K
chooses H, what will 2 choose at that node?
2 2
Clearly, 2 chooses D. 2 thinks again that if 1
B D B D chooses K, 2 will choose D.

⎛ −11⎞ ⎛ −1⎞ ⎛ −10 ⎞ ⎛0⎞

⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎜ ⎟
⎝ −9 ⎠ ⎝ +1⎠ ⎝ −10 ⎠ ⎝0⎠
Figure 5

1
Now, player 1 thinks that it is 2’s best interest
H K
to chooses D regardless of the strategies of
2 2
player 1. Player 1 will choose between H and
B D B D K at 2’s choices. If player 1 chooses H, 1 will
get payoff equals to -1. If 1 chooses K, 1 will
get payoff equals to 0. Therefore 1 will choose
⎛ −11⎞ ⎛ −1⎞ ⎛ −10 ⎞ ⎛0⎞
⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎜ ⎟ K.
⎝ −9 ⎠ ⎝ +1⎠ ⎝ −10 ⎠ ⎝0⎠
Figure 6

page 4
 1
Similarly, any finite game of perfect
H K
information can be solved by backward
2 2
recursion. If there is no tie at any point in the
B D B D process, there is a unique equilibrium. Ties
lead to multiple equilibria. A non-finite game
that can be solved by backward recursion is
⎛ −11⎞ ⎛ −1⎞ ⎛ −10 ⎞ ⎛0⎞
⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎜ ⎟ the Stackelberg oligopoly game.
⎝ −9 ⎠ ⎝ +1⎠ ⎝ −10 ⎠ ⎝0⎠
Figure 7

We will study the Stackelberg Oligopoly in the next chapter. Consider the next
example where the game is of imperfect information type. We will replicate a situation where a
citizen decides whether to commit a crime, and the judge must decide whether to punish a citizen.
The judge has imperfect information since there might be an innocent citizen who may be scared
and then looks suspicious. The judge observes only whether a citizen looks suspicious. A guilty
citizen who committed a crime always appear suspicious, but an innocent citizen looks suspicious
1 19
with probability . Hence, an innocent citizen are revealed innocent with probability . We
20 20
can write the game tree as follows.

Citizen Nature

Commit Don’t
Judge (1/20) (19/20)
Look suspicious Judge
Look Innocent
P N P N P N

⎛ −1 ⎞ ⎛ 1 ⎞ ⎛ −1 ⎞ ⎛0⎞ ⎛ −1 ⎞ ⎛0⎞
⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝1⎠ ⎝ −1 ⎠ ⎝ −1 ⎠ ⎝0⎠ ⎝ −1 ⎠ ⎝0⎠
Figure 8

Each node in an information set must have the same number of branches of
strategies coming out. Otherwise, one could distinguish which node had been reached
according to the number of choices available. Recall that in any dynamic game of perfect
information, one could solve for Nash Equilibria by backward recursion. Judge has 2
information sets and 4 pure strategies: PP, PN, NP, and NN. Before we go on, let us
examine the meaning of subgames. Subgames are a part of a game that can be considered a
game in its own right. Each game is a subgame of itself, and other subgames are called
proper subgames. (Like the definition of subset and proper subsets.) We often require an
equilibrium to make sense not only in the whole game but in every subgame. This is the
notion of subgame perfect Nash Equilibrium, abbreviated as SPE for short. A joint strategy

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 is a subgame perfect Nash Equilibrium if it induces a Nash Equilibrium in every subgame.
Any SPE is also a Nash Equilibrium. Why?

What is a subgame? It has an initial node, which may or may not have its
predecessors. It includes all successors, and includes all other nodes in the same information
set as each node in the subgame. In other words, a node x is said to define a subgame if
whenever y is a node following x and z is in the same information set containing y, then z
must follow x. This can be best explained by the below figures. Hence, we can answer the
above question why SPE is also a Nash Equilibrium.

x x

y z z y

Figure 9: x defines a subgame. Figure 10: x does not define a subgame.

We have seen that the Backward induction strategy (strategies) constitutes a Subgame
Perfect Nash Equilibrium (Equilibria). This technique is nicely tailored to apply to games with
perfect information. It does not, however, immediately extend to the games of complete but
imperfect information. Consider figure 11 in which player 1 has the option of playing a
coordination game with player 2. Let us try to apply the backward induction technique to it.

IN OUT

L R
⎛ 2⎞
⎜ ⎟
⎝ 2⎠
2

l r l r

⎛1⎞ ⎛0⎞ ⎛0⎞ ⎛ 3⎞

⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝ 3⎠ ⎝0⎠ ⎝0⎠ ⎝1 ⎠ Figure 11

As before, the first step is to locate all information sets such that whatever action is chosen
at that information set, the game subsequently ends. For the game in figure 11, this isolates player
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2’s information set, i.e., the point in the game reached after player 1 has chosen IN and then L or
R.

Note that when it is player 2’s turn to play, taking either action l or r will result in the end
of the game. Now, according to the backward induction algorithm, the next step is to choose an
optimal action for player 2 there. But now we are in trouble since it is not at all clear which action
is optimal to player 2. This is because player 2’s best action depends on the action taken by player
1. If player 1 chose L, then 2’s best action is l, whereas if player 1 chose R, then 2 should instead
choose r. There is no immediate way out of this difficulty because by definition of the information
set, player 2 does not know which action playuer 1 has taken.

The idea to proceed is to consider the subgame as a game in its own right. See figure 12.

L R
2

l r l r

⎛1⎞ ⎛0⎞ ⎛0⎞ ⎛ 3⎞

⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝ 3⎠ ⎝0⎠ ⎝0⎠ ⎝1 ⎠
Figure 12

Since this is the game with imperfect information, we can write this in the strategic form as
follows.
1 2 l R
L 1, 3 0, 0
R 0, 0 3, 1

As you can check, there are two pure strategy Nash equilibria of this subgame, (L,l) and
(R, r). There is also a mixed strategy Nash equilibrium, but the discussion will be simplified if we
ignore this for the time being. Let us suppose that when this subgame is reached in the course of
playing the original game, one of these Nash equilibria will be played. Suppose we arbitrarily
choose (L,l) as a Nash equilibrium. Consequently, the resulting payoff vector will be (1, 3) if this
subgame is reached. We now can proceed by backward induction by replacing this entire subgame
with the resulting payoff vector (1, 3). See figure 13. Once done, it is clear that player 1 will
choose OUT at his first decision node.

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 1

IN OUT

⎛ 2⎞
L R ⎜ ⎟
⎝ 2⎠
2 1

IN OUT
l r l r

⎛1⎞ ⎛0⎞ ⎛0⎞ ⎛ 3⎞ ⎛1 ⎞ ⎛ 2⎞

⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝ 3⎠ ⎝0⎠ ⎝0⎠ ⎝1 ⎠ ⎝ 3⎠ ⎝ 2⎠
Figure 13

Altogether, the strategies previously derived are as follows. For player 1, OUT at his first
decision node and L at his second, and for player 2, l at his information set. Not only does these
strategies constitute a Nash equilibrium in the subgame, they form a Nash equilibrium of the
original game as well. Hence, we have seen an example verifying the claim that subgame perfect
Nash equilibrium must induce a Nash equilibrium in every subgame. As you can recall, there are
two pure strategy Nash equilibrium in the subgame, and we arbitrarily chose one of them. Had we
chosen the other, the resulting strategies would have been quite different. Nonetheless, these
resulting strategies, too, are subgame perfect.

Consider figure 14 in which there is a Nash equilibrium but it is not subgame perfect.

IN OUT

2 2

⎛1⎞
L R ⎜ ⎟ L R
⎝ 2⎠
1 1

l r l r l r l r

⎛0⎞ ⎛ 3⎞ ⎛ −1 ⎞ ⎛0⎞ ⎛0⎞ ⎛ 3⎞ ⎛ −1 ⎞ ⎛0⎞

⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝0⎠ ⎝1 ⎠ ⎝ 3⎠ ⎝0⎠ ⎝0⎠ ⎝1 ⎠ ⎝ 3⎠ ⎝0⎠
Figure 13

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 The pure strategy depicted by the arrows in the left game tree is Nash equilibrium because
neither player can improve his payoff by switching strategies given the strategy of the other player.
However, it is not subgame perfect. To see this, note that the strategies induced in the subgame
beginning at player 2’s node do not constitute a Nash equilibrium of the subgame. This is shown in
the right game tree where the subgame has been isolated and the arrow indicates a deviation that
strictly improves player 2’s payoff in that subgame.

Consider the repeated prisoner’s dilemma played twice. Each player’s payoff is the sum of
her payoffs in each round. (This could allow discounting.) At the end of round 1 both player’s
choices are observed by both players, and then round 2 choices are made. Consider an extensive
form for the entire repeated game. In the figure in the next page, how are many subgames? First,
consider the following payoff matrix.

1 2 Collude Defect
Collude 5, 5 0, 6
Defect 6, 0 1, 1
Table 2

Player 1

Player 2 C D Player 2

C D C D
Player 1 Player 1 Player 1 Player 1

C D C D C D C D

2 2 2 2 2 2 2 2

C D C D C D C D C D C D C D C D

Figure 14

There are in total 5 subgames. The whole game itself, and the 4 proper subgames at
the second round at player 1’s nodes. Before moving on, we reconsider the judge game to see how
nature takes part in action.

page 9
 Citizen Nature

Commit Don’t
Judge (19/20)
Look suspicious Look Innocent Judge
(1/20)
P N P N P N

subgame
⎛ −1 ⎞ ⎛ 1 ⎞ ⎛ −1 ⎞ ⎛0⎞ ⎛ −1 ⎞ ⎛0⎞
⎜ ⎟ ⎜ ⎟⎜ ⎟ ⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝1⎠ ⎝ −1 ⎠ ⎝ −1 ⎠ ⎝0⎠ ⎝ −1 ⎠ ⎝0⎠
Figure 15

This can be written in a strategic form game signifying expected payoff as follows.
Judge
Citizen PP PN NP NN
Commit a crime -1, 1 -1, 1 1, -1 1, -1
Don’t commit -1, -1 -1/20, -1/20 -19/20, -19/20 0, 0
Table 3
There exists a unique pure strategy Nash Equilibrium: (Commit a crime, PP). Doesn’t this
sound strange that it is in people’s best interest to commit a crime and the judge will always punish
even some innocent people. However, it is easily seen that this Nash Equilibrium is not subgame
perfect. When citizen who does not commit a crime reaches the node “look innocent”, the judge
will choose N; not punish the innocent. Thus, this means (Commit, PP) is not credible. Therefore,
we can scratch out the strategy where the judge punish the innocent. It is left to the reader to find
the Nash Equilibrium of this judge game. (Hint: we need mixed strategy Nash equilibrium in the
reduced strategic form game.)

We are now consider the two period Prisoner’s dilemma. If a game is repeated,. Is the
outcome just a repetition of one period game? Can collusion be sustained? Consider the game in
table 2. Assume the discount factor is δ >0. We examine the proper subgames to find SPE.
Suppose that we consider the leftmost subgame, ones that follows CC in figure 11.

C D

2 2

C D C D

⎛ 5 + 5δ ⎞ ⎛ 5 ⎞ ⎛ 5 + 6δ ⎞ ⎛5+δ ⎞
⎜ ⎟⎜ ⎟ ⎜ ⎟ ⎜ ⎟
⎝ 5 + 5δ ⎠ ⎝ 5 + 6δ ⎠ ⎝ 5 ⎠ ⎝5+δ ⎠
Figure 16

page 10
 In each proper subgame, payoffs are increasing affine functions of payoff in one period game.
An affine function is just a monotonic transformation of a payoff, and such a transformation leaves
preferences unchanged. Therefore, in each proper subgame, DD is the unique Nash Equilibrium.
We work backward to period one. Each player knows that both of them will choose D in period
two. Thus, payoffs are just the same as in the first period payoff plus δ . So, first period decision
amounts to decision in one period game.

To write the strategies used in SPE, one might think that a strategy is simply a pair of
instructions (1st period action, 2nd period action). But there are four possible first period outcome:
(C, C), (C, D), (D, C), and (D, D), and these represents four separate contingencies in which each
player might be called upon to act. Therefore, each player’s strategy consists of five instructions
denoted (v, w, x, y, z), where v is the first period action and w, x, y, and z are the second
period actions to be taken following the first period outcomes, (C, C), (C, D), (D, C), and (D, D)
respectively. In this example, the SPE is {(D, D, D, D, D), (D, D, D, D, D)}, which means “choose
D in the first period and then choose D in the second period regardless of the first period outcome.
Therefore, in prisoner’s dilemma repeated any known finite number of times, the only unique SPE
has each player choosing D at each information set. The generalization of any game with a unique
Nash Equilibrium where each player chooses ai* is that any finitely repeated game also has a unique
SPE where each player chooses ai* at each player’s information set.

So far, this is quite disappointing. We still do not discover the theoretical reason why there
is collusion in oligopoly market. We will move to the infinitely repeated games. We let the number
of periods be infinite. Let π ki be player I payoff in period k, with discount factor 0 < δ < 1 to
∞
ensure that the discounted present value of payoff stream, Π i = ∑δ
k =1
k −1
π ki < ∞ . We might also add

complication to the model by adding the probability of continuing an additional round at each
∞

∑ (qδ )
k −1
period as 0 < q < 1 , and work with the expected payoff E Πi = π ki . Since this is an
k =1

infinitely repeated game, we have no last period to use a backward recursion. How can we analyze
this problem?

Remember that payoff is just a monotonic transformation so this does not change
preferences, even though it is an infinite period game, since payoffs increase by a constant.
Therefore, we still have the same SPE as in the case of finitely repeated games. This seems
hopeless. But as in the strategic form games can have more than one Nash Equilibrium, there may
also be more than one SPE!

Each player needs to maximize the discounted present value. This depends critically
on the discount factor δ = 1+1r , with r as the discount rate. The player with high discount rate will
want to earn high payoff in early periods even if it means sacrificing future profits, and the player
with low discount rate will have a longer time horizons to sacrifice the current payoff to earn higher
payoff in the future. Thus, collusion might be sustained if each player is patient enough to sacrifice

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the current payoff in order to collude to gain the future payoff. That is, collusion might be
sustained if the discount factor, δ , is sufficiently close to 1. Hence, there might be an SPE in
which all players choose C at each point along the equilibrium path, so the outcome has both
choosing C forever. This is not as simple as each player chooses C at every information set since we
have already shown that it is not possible in each subgame to choose C. Choosing C at every
information set is not even a Nash Equilibrium. This strategy in which players may choose C
forever is called the Grim Trigger strategy. Of course, this involves discount factor. If δ is close
to zero, the collusion might not be sustained or may be sustained only in early periods. Players
using Grim Trigger strategy will choose C if and only if no one has ever chosen D. If someone
chooses D, then both chooses D forever as a punishment deviating from the collusion. Hence, the
outcome is that choosing C forever is an SPE, dependent on the value of the discount factor. If the
discount factor is close to one, or in other words, if the discount rate is low, then players are patient
enough to wait for future payoffs. If the discount factor is close to zero, or in other words, if the
discount rate is high, then players are anxious to get payoffs in early periods.

We must show that choosing C forever is an SPE. Notice that there are two kinds of
subgames. First, the subgame where someone has previously played D, and then GTS specifies D at
every information set, is a Nash Equilibrium in this subgame. Second, the subgame where no one
has ever played D, then the Grim Trigger Strategy gives the discounted present value as
∞
PV = 5 + 5δ + 5δ 2 + ... = ∑ 5δ
k =1
k −1
= 5 / (1 − δ ) . We will check that following GTS gives the best

response of each player.

Suppose that the payoff stream of player i if i chooses D after m>0 periods is
5, 5, 5, …, 5, 6, 1, 1, 1, …. The payoff stream of choosing C forever is 5, 5, 5, … .
m periods

The discounted present value from choosing D after m periods equals

π defect = 5 + 5δ + 5δ 2 + ... + 5δ m −1 + 6δ m + δ m +1 + δ m +2 + ...

The discounted present value from choosing C forever equals

π collude = 5 + 5δ + 5δ 2 + ... + 5δ m −1 + 5δ m + 5δ m +1 + 5δ m +2 + ...

Now, it should be clear that both players will cooperate if and only if
π collude > π defect

5 + 5δ + 5δ 2 + ... + 5δ m −1 + 5δ m + 5δ m +1 + 5δ m +2 + ... > 5 + 5δ + 5δ 2 + ... + 5δ m −1 + 6δ m + δ m +1 + δ m +2 + ...

4δ m +1 + 4δ m +2 + ... > δ m

4δ m +1 (1 + δ + δ 2 + ...) > δ m
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 4δ
>1
1−δ

1
∴δ > .
5

Hence, if δ > 0.2 , GTS yields a Nash Equilibrium in every subgame and thus SPE is to
1 1
choose C forever. If we relate the discount factor to the discount rate, δ = > . Then, we
1+r 5
have r <4. Therefore, if the discount factor is not too low, or if the discount rate is not too high,
players are patient enough to sustain the collusion, and cooperation can be supported as an SPE.

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