Behavioral Game Theory

Alexia Gaudeul
MA BEHAVIORAL GAME THEORY Georg-August-Universität

Göttingen
Summer 2018
BEHAVIORAL GAME THEORY
* Two aspects to game theory:
* How games should be played: normative
* How games are played: positive
* Normative  can be derived from introspection,
discussion, mathematics, logic
* Positive  can be derived from experience,
experimentation, empirics.
EXAMPLES
EXAMPLE: ULTIMATUM GAME
* Two roles, first move by the proposer, second
move by the responder
* Proposer: You have 10€ and must decide how much to
give to the responder and how much to keep for
yourself.
* However, if the responder rejects your offer, then you
both get nothing.
* How much do you give?
EXAMPLE: ULTIMATUM GAME
* Responder: The proposer gave you 3€ out of a
total of 10€ and keeps the rest.
* If you accept the offer you keep the 3€ and the
proposer keeps the rest.
* If you reject the offer you both get nothing.
EXAMPLE: COORDINATION GAMES
You choose at the same time as
Player B
another player whether to play
left or right.
Left Right
* If you both play left, you both
get 10
Left 10,10 0,0
* If you both play right, you both
Player A get 10
Right 0,0 10,10 * If one plays right and the other
left, you both get 0
EXAMPLE: CENTIPEDE GAME
* You are paired with someone else over two periods
* In the first period, you decide to stop or to continue
* If stop, you get 4€, the other person gets 1€
* If continue, then there is a second period:
* In the second period, the other person decides to stop or
continue.
* If stop, then you get 3€, the other person gets 6€
* If continue, then you get 5€, the other person gets 5€.
EXAMPLE: BEAUTY CONTEST
1. Choose a number between 0 and 100
2. Other people in the class also choose a number
between 0 and 100
3. I collect your numbers and calculate the mean.
4. The person with the number closest to
70% ×mean wins 2€.
EXAMPLE: COMMON VALUE AUCTION
1. I show you a glass full of coins. I know how much money
there is in the glass.
2. You each write how much you are ready to pay to get
an amount equal to how much money there is in the
glass.
3. I will give an amount of money equal to how much there
is in the glass to the person with the highest bid.
1. Note: I will let you check how much there is in the glass after
the game is played.
4. That person in turn must pay me their bid.
GENERAL PRESENTATION
EXPERIMENTS IN GAME THEORY
* Predictions from game theory are very sensitive to
small changes in the context
* Experiments allow one to maintain control over everything
* Payoffs
* Identity and history of the players
* Timeframe of the game
* Information available to the players
* Order of moves
* …
EXPERIMENTAL ECONOMICS
* A new old field in economics
* Early economists were happy to take account of
irrational behaviour among economic agents, and to test
their theories experimentally or in the field.
* Daniel Bernoulli and his solution of the St Petersburg Paradox (risk aversion)
* Adam Smith: “The theory of mental sentiments”, emphasizing sympathy for
others, vs. “The wealth of nations”, emphasizing self-interest.
* John Maynard Keynes and his “Animal Spirits” (confidence, expectations)
* This early openness was supplanted by neo-classical
economics.
* All behaviour must be maximizing some utility / profit
* People have rational preferences
* Equilibria takes account of all relevant information
* Little testing, mainly theory.
* Resurgence in interest in the behavioural and
experimental approach
* Integrating insights from psychology, neuroscience,
decision theory.
* Limits in the ability of economic agent to process
information  Heuristics and biases that result.
* Test with data from laboratory and field experiments.
TYPICAL EXPERIMENT IN ECONOMICS
* Incentivized * Simplified (represent
* Controlled (change an economic situation,
one thing at a time from not reproduce it)
a baseline) * Detailed instructions to
* Most are subjects (avoid
computerized and use misunderstandings)
student subjects * No deception
REFERENCE BOOK
* Camerer, C. (2003). Behavioral
Game Theory: Experiments in Strategic
Interaction. New York, N.Y. : Princeton,
N.J: Princeton University Press.
CHAPTERS
1. Dictator, Ultimatum and Trust Games
2. Mixed Strategy Equilibrium
3. Bargaining
4. Dominance Solvable Games
5. Learning
6. Coordination
7. Signaling and Reputation
OTHER USEFUL BOOK
* Friedman, D. & Sunder, S.
(1994). Experimental Methods: A
Primer for Economists.
Cambridge University Press.
CHOICE OF TOPIC FOR EXPERIMENTS
* Read the introduction paragraph for each chapter in
Camerer.
* Choose a chapter that raises your interest
* Read that chapter
* Select a sentence or idea that you want to investigate
further
* Or select a reference mentioned in the chapter and read
that reference (article mainly)
EXPERIMENT
* You can choose to reproduce an experiment from
the literature
* Or you can choose to make a variation on a well-known experiment
* Or you can even design your own game!
* You should be able to predict the equilibrium of
the game, and what people will play
EXPERIMENT
* Then you collect data by letting others play your
game
* This requires writing instructions to explain to them
what the game is
* Instructions should be precise and complete
* You have to make sure to completely control the
context of the game
EXPERIMENT
* Then you analyze the data, compare what
people did with your predictions
* Finally, you try to find explanations for why
people played what they did
PRESENTATION
* Not graded, in groups.
* 10-15 mn presentation + 10-15 mn questions and
discussion
* What is the economic issue, how is it modelled?
* How did you go about running the experiment?
* What are the findings from experiments?
* How do your findings compare with theory? With
reality? With other related experiments?
“Whatever is well conceived is clearly
ESSAY (15 PAGES)

said, and the words to say it flow with
ease.” (Boileau, 1674)
* Individually written.
* The essay puts the work done within the group in
writing
* Go over the same themes as the presentation, but:
* more detailed,
* well referenced,
* full sentences and
* clear explanations
ESSAY (15 PAGES)
* Prove good understanding of the theory that was
tested,
* of the reasons for running the experiment,
* of how it was run,
* of what were its findings, and
* why they matter.
DATES
* Lectures: Tuesday: 14:00 - 16:00
* Location: ZHG 1.142
* Learning theory, methods, some statistics.
* Exercises: Wednesday: 16:00 - 18:00.
* Location: MZG 6.115 (Labor)
* Mostly playing games and analyzing them.
* Essay deadline: 11.08.2018 (one month after last
lecture)
DATES
* Lectures take place over 14 weeks but the last
two to three weeks will be devoted to
presentations of group work.
* Exercises also take place over 14 weeks but the
last two to three sessions will be available for
running experiments on other students.
LECTURE 2: QUANTAL RESPONSE Behavioral game theory
Alexia Gaudeul
EQUILIBRIA University of Göttingen
QUANTAL RESPONSE EQUILIBRIA
* Nash-equilibrium assumes correct beliefs about the
behavior of others and also correct responses given
those beliefs.
* Under Quantal Response Equilibria, we have noisy
responses to correct beliefs.
* McKelvey, R. D., & Palfrey, T. R. (1995). Quantal Response
Equilibria for Normal Form Games. Games and Economic
Behavior, 10(1), 6–38.
https://doi.org/10.1006/game.1995.1023
* Actions with higher expected payoffs are then
chosen more often, but not always.
* Example:
L R
U 9,0 0,1
D 0,1 1,0
NASH EQUILIBRIUM
* Nash equilibrium is such that
* For UD player, play U with frequency 𝑢𝑢 s.t. LR player
indifferent between L and R:
* 𝑑𝑑 = 𝑢𝑢 𝑎𝑎𝑎𝑎𝑎𝑎 𝑑𝑑 + 𝑢𝑢 = 1 → 𝑑𝑑 = 𝑢𝑢 = 1/2
* For LR player, play L with frequency 𝑙𝑙 s.t. UD player
indifferent between U and D:
* 9𝑙𝑙 = 𝑟𝑟 𝑎𝑎𝑎𝑎𝑎𝑎 𝑙𝑙 + 𝑟𝑟 = 1 → 𝑙𝑙 = 1/10, 𝑟𝑟 = 9/10
NOISY PAYOFFS
* QRE is such that the probability to play an action is
proportional to its expected payoff:
* Expected payoff of U is:
* 9𝑙𝑙 + 𝜖𝜖𝑢𝑢 with 𝜖𝜖𝑢𝑢 an error in approximation of the payoff
of U by UD player.
* Expected payoff of L is:
* (1 − 𝑢𝑢) + 𝜖𝜖𝑙𝑙 with 𝜖𝜖𝑙𝑙 an error in approximation of the
payoff of L by LR player.
Perceived payoffs are then
L R
U 9 + 𝜖𝜖𝑢𝑢 , 0 + 𝜖𝜖𝑙𝑙 0 + 𝜖𝜖𝑢𝑢 , 1 + 𝜖𝜖𝑟𝑟
D 0 + 𝜖𝜖𝑑𝑑 , 1 + 𝜖𝜖𝑙𝑙 1 + 𝜖𝜖𝑑𝑑 , 0 + 𝜖𝜖𝑟𝑟
UD chooses U if 9𝑙𝑙 + 𝜖𝜖𝑢𝑢 ≥ 1 − 𝑙𝑙 + 𝜖𝜖𝑑𝑑
That is, if 𝜖𝜖𝑢𝑢 ≥ 1 − 10𝑙𝑙 + 𝜖𝜖𝑑𝑑
The probability of this happening is
+∞
� (1 − 𝐹𝐹 1 − 10𝑙𝑙 + 𝜖𝜖𝑑𝑑 𝑓𝑓 𝜖𝜖𝑑𝑑 𝑑𝑑𝜖𝜖𝑑𝑑
−∞
(assuming both players have the same error distribution and that error distribution is also same for both actions)
* If error terms are distributed according to the
extreme value distribution (see R file qre_graph.R),
then UD will play U with probability:
𝑒𝑒 𝜆𝜆 9𝑙𝑙
𝑢𝑢 = 𝜆𝜆 9𝑙𝑙
𝑒𝑒 + 𝑒𝑒 𝜆𝜆(1−𝑙𝑙)
* 𝜆𝜆 is a measure of the precision of players.
* High 𝜆𝜆 → very precise  converges to NE.
THE EXTREME VALUE DISTRIBUTION
𝜆𝜆 = 4
𝜆𝜆 =1
Normal distribution
𝜆𝜆 = 2
* Similarly:
* Expected payoff of L is 1 − 𝑢𝑢
* Expected payoff of R is 𝑢𝑢
* LR will play L with probability:
𝑒𝑒 𝜆𝜆 1−𝑢𝑢
𝑙𝑙 =
𝑒𝑒 𝜆𝜆 1−𝑢𝑢 + 𝑒𝑒 𝜆𝜆(𝑢𝑢)
* Equilibrium is therefore such that
𝑒𝑒 𝜆𝜆 9𝑙𝑙
𝑢𝑢 = 𝜆𝜆 9𝑙𝑙
𝑒𝑒 + 𝑒𝑒 𝜆𝜆(1−𝑙𝑙)
𝜆𝜆 1−𝑢𝑢
𝑒𝑒
𝑙𝑙 = 𝜆𝜆 1−𝑢𝑢
𝑒𝑒 + 𝑒𝑒 𝜆𝜆(𝑢𝑢)
* System of two equations with two unknowns.
* This can be rewritten as
1 − 𝑙𝑙
1 ln( 𝑙𝑙 )
𝑢𝑢 = +
2 2𝜆𝜆
1 − 𝑢𝑢
1 ln( 𝑢𝑢 )
𝑙𝑙 = −
10 10𝜆𝜆
* Here we see that the NE is a special case of the QRE
whereby 𝜆𝜆 → ∞
* To find values of u and l we can proceed by
successive approximations for given 𝜆𝜆 e.g.
1−𝑙𝑙
1 ln( )
𝑙𝑙
* 𝑢𝑢 = + if l=1/10 is …
2 4
FINDING SOLUTIONS WITH APPROXIMATIONS
1 − 𝑙𝑙
1 ln( )
𝑢𝑢 = + 𝑙𝑙 1 − 𝑢𝑢
2 2𝜆𝜆 1 ln( )
𝑙𝑙 = − 𝑢𝑢
10 10𝜆𝜆
QRE graph when 𝜆𝜆 = 1

EVOLUTION OF PROBABILITIES AS A FUNCTION
OF 𝜆𝜆
1.00
0.90
0.80
0.70
0.60
0.50
0.40
0.30
0.20
0.10
0.00
0.00 10.00 20.00 30.00 40.00 50.00 60.00
proba u proba l
[see gbt file “basic course example.gbt”, to be used with Gambit software]
FIT WITH OBSERVED PLAY
* To be seen in seminar, comparing results of play
with theory.
L R
RISK AND PAYOFF DOMINANCE U 75,75 25,60
D 60,25 60,60
* Two equilibria are U,L and D,R.
* U,L is efficient (also known as payoff dominant)
* D,R is less risky (aka risk dominant)
* In choosing D,R, each player insures himself a
payoff of 60 regardless of what the other player
does. So, Y is a risk‐free or “safe” strategy.
L R
RISK AND PAYOFF DOMINANCE U 75,75 25,60
0.60
D 60,25 60,60
0.50
0.40
0.30
0.20
0.10
0.00
0.00 0.20 0.40 0.60 0.80 1.00 1.20
proba u proba l
As 𝜆𝜆 increases, the equilibrium converges to (D,R).

RELATION BETWEEN QRE AND RISK-DOMINANCE
* Two students in a group
* Can work hard (cost 2c)
or be lazy (cost c). L R
* Only if both work hard U 1 − 𝑐𝑐, 1 − 𝑐𝑐 1 − 𝑐𝑐, 1 − 2𝑐𝑐
do they get payoff 2. D 1 − 2𝑐𝑐, 1 − 𝑐𝑐 2 − 2𝑐𝑐, 2 − 2𝑐𝑐
* Otherwise, get payoff

1.
QRE AND RISK DOMINANCE
* DR payoff dominates UL because 2-2c>1-c as long as c<1
(assumed).
* Risk of DR is measured as product of the losses in case of
deviation for both players=
* 2 − 2𝑐𝑐 − 1 − 𝑐𝑐 × (2 − 2𝑐𝑐 − 1 − 𝑐𝑐 = 1 − 𝑐𝑐 2 for DR
* 1 − 2𝑐𝑐 − 1 − 𝑐𝑐 × (1 − 2𝑐𝑐 − 1 − 𝑐𝑐 = 𝑐𝑐 2 for UL
1
* Therefore, DR risk dominates UL if 𝑐𝑐 < , is risk dominated if
1 2
𝑐𝑐 >
2
QRE AND RISK DOMINANCE
* Does the QRE translate risk-dominance? [compare qre
1 1
when 𝑐𝑐 < and when 𝑐𝑐 > ]
2 2
* Yes, if for example c=0.1, then as 𝜆𝜆 increases,
convergence to DR
* Conversely, if c=0.9, then as 𝜆𝜆 increases, convergence
to UL
*  as precision increases, then people tend to choose
the risk-dominant equilibrium.
QRE AND TREMBLING-HAND PERFECT
EQUILIBRIUM
* The two concepts are related, since people may
make mistakes.
* However, they do not always lead to the same
outcome.
* [example, cf. McKelvey & Palfrey, Section 4]
LECTURE 3: EXPERIMENTAL Behavioral game theory
Alexia Gaudeul
METHODOLOGY University of Göttingen
(Adapted from lecture slides by Alec Sproten & Lilia Zhurakhovska)

WHY EXPERIMENT?
WHY EXPERIMENT?
* Happenstance data are a by-product of uncontrolled

processes.
* Researcher observes the outcomes but generally not the
actions.
* Ex-post and imperfect control
* However, results may be more externally valid?...
* Experimental data are collected under controlled
conditions.
* Researcher observes both the outcomes and the actions.
* Ex ante and almost perfect control (easier to process)
* But do results hold in practice?
3
WHY EXPERIMENT?
* Application 1: Testing Theory

* Economic theory provides predictions of the effect of
changes in variables.
* Implement and hold constant those conditions of the
theory (e.g. preferences, technology, institutions) that
you do not want to check.
* Vary those components of the theory which effect you
want to test.
4
WHY EXPERIMENT?
* Application 2: Establish empirical regularities

* Prove some empirical regularities to direct the
development of new theories.
* E.g. Fehr and Schmidt, “A Theory of Fairness,
Competition, and Cooperation”, QJE, 1999.
* “In addition to selfish individuals, there are people
who dislike outcomes that are perceived as inequitable.”
5
WHY EXPERIMENT?
* Application 3: Comparing institutions

* To learn something about the efficiency
properties of institutions it is not necessary to have
a full theory that explains and predicts behaviors.
* Measure of welfare: total money earnings of all
subjects in the experiment.
* Example: double auction versus one-sided
continuous auction.
6
WHY EXPERIMENT?
* Application 4: Wind Tunnel Experiments

* What would happen if one changed policies or implemented
new institutions.
* Does the reduction of entry barriers increase aggregate welfare?
* Which auctions generate the higher revenue for government
securities?
* Do tradable emission permits allow efficient pollution control?
* How should airport slots be allocated?
* How can the market for hospital doctors be organized efficiently?
* Which institutions ensure an efficient provision of public goods?
* etc.
* Economic experiments allow us to examine these questions
empirically.
7
HOW TO BUILD AN EXPERIMENT
DESIGNING AN EXPERIMENT
* Before designing an experiment, you must have

a good research question
* “The formulation of a problem is often more essential
than its solution which may be merely a matter of
mathematical or experimental skill. To raise new
questions, new possibilities, to regard old questions from
a new angle, requires creative imagination and marks
real advance in science.”
* (A. Einstein and L. Infeld, The Evolution of Physics).
9
* After having formulated a research question, you

must build a design to address the research question
* How will conditions differ between different participants
or over time? (treatments ← more on this later)
* Then determine what participants will do
* instructions, rules of the game, protocol of the experiment
← more on this later
* Finally, make sure to collect enough observations to
check your predictions  power and significance test.
* Minimum 80% probability to detect an effect of your
treatments
* Maximum 5% probability that the effect is due to chance
10
* A good experiment
* controls for the most plausible alternative hypotheses
* allows to distinguish between them
* The most plausible alternative hypotheses depend on
* who you are talking to
* recent developments in theory
* recent developments in the laboratory
* recent developments in the field
* → a good experiment is a „creature of its time“ (R.
Nagel)
11
* How much realism should I impose on my

experiment?
* Should I try to mimic “reality“ or to reproduce a
formal model?
* Experiments are usually quite simple compared
to “reality“
* Experiments are in some respect simpler than
required by formal models.
12
* You do not want to replicate the complexity of field

environment in the lab
* Reality is its own best model
* A map will never be as detailed as reality
* But this makes it more useful!
* A large amount of details will always remain
uncaptured
* Complexity could prevent to disentangle causes and
effects
* Simplicity enhances control!
13
* You do not also want to replicate an economic model

* Hard to replicate the precise assumptions of a
formal model
* Even if able to reproduce model in the lab:
* There is no point in testing a model in the lab: A model is
by definition correct as long as it was solved correctly.
* Rather, you might want to experimentallly test a model by
relaxings the strong assumptions that are necessary to solve
it and showing that results are maintained (even though now
you cannot prove it!)
14
* Also, models are not a good guide for

experiments because they leave out details
* That are dispensable in terms of theory
* But important in terms of behavior
15
* Create simplest possible economic environment

* Accurate and clear instructions
* Control questions or trial runs
* → Reduces ambiguity in the interpretation of results
16
WHAT IS A TREATMENT?
TREATMENTS
* Experiments are designed to test hypotheses.

* Hypotheses can be tested by contradiction
* If A is true then B is true  to be tested by
comparing results when A is true and when A is false.
* Therefore, across sessions, subjects or across time,
you will want to keep everything constant except
one change: the treatment variable
* Treatment 1: A is true
* Treatment 2: A is false
18
TREATMENTS
* Implementing one change only between

treatments should allow you to draw conclusions on
causality effects.
* E.g., cost, available information, trading rule, choice
set, subject pool
19
TREATMENT(S): EXAMPLE
* Ultimatum game:
* A can send a fraction 𝑓𝑓 of a pie of size 𝑝𝑝 in
increments of 𝑠𝑠 to B
* B can accept or reject, if rejects, receives 𝑥𝑥.
* You could decide for:
* A can send a fraction 𝑓𝑓 of a pie of size 10 in
increments of 1 to B  A can send 0, 1, 2 , …, 9, 10
* If B rejects, both players receive an amount of 0 ECU
20
TREATMENTS: EXAMPLE
* A is choosing the fraction 𝑓𝑓

* You can actually let him choose a fraction (0%, 10%,
…, 100%) or you can let him choose a number.
* You can restrict A’s action space: e.g., A can only send
anything between 5 and 10.
* You can let 𝑓𝑓 be chosen by a computer and not by A.
* B can accept or reject
* You can restrict B’s action space: e.g. B must accept
any 𝑓𝑓 that is above 50%.
* What else can you decide to change?
21
TREATMENTS: EXAMPLE
* What can be treatment variables?

* In fact, all the things you can choose can be your
treatment variables!
* You should always vary only one thing between
the treatments and keep anything else constant!
* Baseline: no restriction, i.e. A can send 0, 1, …, 9, 10.
* Treatment LowMin: A can send 2, 3, …, 9, 10.
* Treatment HighMin: A can send 4, 5, …, 9, 10.
(see Falk, Fehr, Fischbacher, 2008)
22
TREATMENTS
* Within-Subject Design:
* Each subject participates in several treatments.
* It allows to control for changes in individual behavior (for
the same individual).
* History may matter : Interdependence of treatments.
* Between-Subject Design:
* Each subject participates only in one treatment.
* It allows only to control for changes in average behavior.
* Treatments do not influence each others.
23
TREATMENTS
* Between-Subject Design:
* You do not incite subjects to display behavioral
changes between treatments A and B (Rosenthal, 1976;
White, 1977).
* If randomization is successful, average behaviors can
be compared.
* Shorter experiment (But more sessions…)
24
TREATMENTS
* Within-Subject Design:
* You can find out how the change of institutions
influences behavior for the same individual (compare
pre vs. post).
* You collect more information (Comparison can
already be made within one session).
25
TREATMENTS
* In within-subject design, always control for order-

effects :
Order of Treatments in Sessions Within subject Between subject
Session 1 AB A
Session 2 BA B
Session 3 AB A
Session 4 BA B
26
TREATMENTS
* Make sure that treatments are assigned randomly!

* E.g., do not assign first half of subjects arriving in the
lab to institution A and the second half to institution B
* E.g., do not run sessions in condition A only in the
morning and sessions in condition B only in the evening
(Kouchaki & Smith 2013)
* Which problems can arise if you do not randomize?
* What can you randomize?
27
HOW TO PREPARE AN EXPERIMENT
PREPARING AN EXPERIMENT
* Who will be your participants?  more on this later

* What is the environment you will be exploring?
* Preferences, technologies, initial endowment
* → implemented by appropriate (monetary) incentives
* What will be the rules of the game?
* Feasible actions
* Sequence of actions
* Information conditions
* → defined by experimental instructions
29
* Write instructions for each treatment

* Write a protocol: how the experiment will
proceed over time
* As detailed as possible to ensure replicability
* Questionnaire
* Computerized or not?
* Get money to pay participants.
30
* Run pilot experiment

* Improve the design/instructions
* Run the experiment
* Recruit participants
* Run the experiment
* Analyze data
* Write your paper!
31
LOGISTICS
* Paper and Pencil vs. Computerized

* Lab vs. Internet
* Classroom Experiments
32
LOGISTICS
* Advantages of paper and pencil experiments

* Flexibility (quickly develop new treatments); can be
conducted easily in developing countries
* Relatively low costs
* Natural environment (?)
* Not a lab with computers, etc. a classroom
* Procedures more visible and credible
* E.g., throw dice in front of people instead of random device
* Matching of people is easy to recognize (walking
around of experimenter)
33
LOGISTICS
* Advantages of computerized experiments

* Better control
* No communication among subjects
* Less interaction with experimenter
* Generally simpler to run (e.g., markets)
* Avoid mistakes
* Automatic data collection (data has not to be
digitalized)
* Fixed costs have declined in recent years
34
LOGISTICS
* Advantages of online experiments

* Often requiring far less money and time to design and
conduct
* Access to more different subjects (not only students)
* Possible to make international comparisons
* Online labor markets exist
* oDesk, Freelancer, Elance, Guru and Amazon’s Mechanical Turk (MTurk)
* (MTurk) most popular
* Difficulty of creating common knowledge among
participants
* Population is often heterogenous
35
LOGISTICS
* Advantages of laboratory experiments

* Easy to create common knowledge among
participants
* E.g., by reading out instructions
* Possible to answer questions that subjects may have
about the instructions
* More information about identity of the subjects
* In general more control (can be ensured that always
the same persons do the experiment!)
* Possibly more reliable data due to higher stakes
36
LOGISTICS
* Advantages of classroom experiments

* Easy access to participants
* Cheap to conduct
* Students learn the value of economic exchange
* If the experiment does not require anonymity, it is
easy to conduct in a class – otherwise problems may
occur
37
WRITING INSTRUCTIONS
INSTRUCTIONS
* Do not reveal your own experimental goals

* Do not deceive subjects or lie to them!
* Salience and dominance are lost when subjects doubt
the announced relation between actions and rewards
* Subjects may participate in other experiments
39
INSTRUCTIONS
* Simple language
* Simple, short and unambiguous sentences
* Use redundancies if issues are complicated
* Consistent/uniform descriptions and framing
* Avoid suggestive terms if it does not help you
* Punishment: negative points (see framing)
* Defect: contribute nothing
* Avoid suggesting any behavior („you would do us
a favor if…“)
40
INSTRUCTIONS
* Complete description of the rules of the game

* Sequence of decisions
* Interaction
* Payoff consequences
* Different ways to explain the payoff function
* Formula
* Verbal explanation
* Table
* Figure
* Examples (but avoid being suggestive)
41
INSTRUCTIONS
* Control questions
* Check understanding
* Knowing who is done with the instructions
42
INSTRUCTIONS
* In complicated experiments it may make sense that

subjects have to try out the rules of the game first
* Without monetary incentives
* Advantage
* It guarantees subjects’ understanding from the first paid period
on
* Allows answering “new” questions of subjects that arise after
learning trials
* However
* You lose information about the “true” first period
* No control on what subjects infer from the learning trials
* Subjects may send (costless) signals
43
INSTRUCTIONS
* Instructions are never 100% complete and clear

* Give instructions to someone, who has no idea of
the experiment and ask him/her to read them
* If subjects does not understand them, there will be
subjects in the lab who do not understand it
44
INSTRUCTIONS
* How to present instructions?

* Distribute to subjects
* (Some experimenters give instructions on the computer screen)
* Ask them to read the instructions
* You may need to read them aloud in some
experiments if common knowledge of the rules of the
game is necessary.
45
INSTRUCTIONS
* What if subjects do not understand something?

* Answer their question
* Use same wording as in the written instructions
* Hint them to the respective phrase/paragraph in the
instructions
* If you find out that indeed something is unclear in the
instructions (many subjects ask the same question) – say
the information out loud such that everybody gets it
AND say this information out loud in each session (if
possible)
46
HOW DO I GIVE INCENTIVES AND
ELICIT TRUTHFUL RESPONSES?
INCENTIVES
* Payments should vary with subjects‘ actions

* That is, subjects must be able to influence their own payoff
by their action.
* Otherwise, this is not anymore an economic experiment
* Economics is about maximizing, choosing the best action
from your point of view!
* This does not mean that you believe that subjects are
only maximizing their money payoff.
* But their behavior must be robust to monetary incentives.
* E.g. it is easy to be altruistic if it does not cost you anything.
* What is more interesting is if altruism survives in an economically relevant
setting.
48
INCENTIVES
* Incentives are generally monetary

* Money is fungibles
* Everyone values money the same (?)
* Average payment should exceed average
opportunity cost, i.e. what people could earn by
doing something else, otherwise they will not come
back.
49
ELICITATION METHODS
* Direct-response method
* Subjects make decision whenever it is their time to do
so.
* Strategy method (Selten, 1967)
* Subjects have to make contingent decisions for all
nodes at which they may have to play.
* What do you think are the pros and cons of both
of these methods?
50
ELICITATION METHODS
* Direct-response method
* Makes decisions simpler for subject
* Does not rely on hypothetical future situations
* Does not allow to explore all situations (Trust-Game
example: What if player A only send low amount?)
* Fewer observations
51
ELICITATION METHODS
* Strategy method
* More information on individual decisions
* Allows to obtain information even at nodes that are
only reached occasionally in the course of play
* Subjects can compare their decisions and be more
consistent
* Could confuse subjects if the presentation is not clear
enough
* Subjects may be less spontaneous (e.g. emotion-
based decisions, such as punishment)
52
CHOOSING A SUBJECT POOL
SUBJECT POOL
* Students vs. Professionals

* Demographic variables (Gender, Age …)
* Running experiment outside of the lab?
* Controlling for preferences and attitudes
54
SUBJECT POOL
* Most participants are undergraduate or graduate

students
* If laboratory is in an econ/management department and
the department is far away from other departments, most
subjects are econ/management students.
* Why are students a good subject pool?
* Convenience in recruiting on university campuses
* Low opportunity cost for students
* Relatively steep learning curve
* Some lack of exposure to confounding external information
* Subject pool relatively homogenous  treatment results come
from different treatments and not actually from different subjects
(control)
55
SUBJECT POOL
* Grad students can be bad subjects:

* Respond to theories, they have in mind
* Respond to their understanding of the experiment instead of to
the incentives you have implemented.
* The use of students is criticized because one could not
generalize the experimental results (e.g., Cunningham et al.
1974; Enis et al. 1972).
* However, we want to draw qualitative rather than quantitative
conclusions.
* We do not look for the answer to a question like: “What is the
exact amount of money given in a dictator game by an average
person?”
* Students are not that far away from the labor market.
56
SUBJECT POOL
* Some demographic variables could directly

affect the experimental results.
* Recent research in experimental economics have
emphasized for example gender differences in
behavior (e.g. attitude toward competition)
* These effects are generally not included in the
existing economic theories.
57
SUBJECT POOL
* Differences in populations can therefore matter,

especially if these differences interact with the
treatment variables.
* Think about that before conducting the
experiment
* Ex-ante control (randomized assignment to
treatments)
* Ex-post control (Have a short questionnaire on
demographics)
58
SUBJECT POOL: DEMOGRAPHIC CONTROLS
* Example of questionnaire on demographics:

* How old are you?
* Are you male or female?
* How many siblings do you have?
* How many times have you taken part in experiments so far?
* What are you studying / What did you study?
* If you are enrolled in a university, what semester are you in?
* Is German your native language?
* What mathematics grade did you have in your A-levels/Abitur?
* Do you have a regular job with more than ten working hours per
week?
* How much money do you have at your disposal per month?
59
SUBJECT POOL: OTHER CONTROLS
* You may want to control for subjects’ individual

and social preferences (e.g. to explain individual
heterogeneity)
* Run additional short “experiments” after the main
experiment
* Elicitation of Subjects’ Risk Preferences
* Elicitation of Loss Aversion
* Elicitation of Beliefs
* …
* Post experimental questionnaire could be used to
elicit subject’s psychological traits
60
* Risk from the German Socio-Economic Panel GSOEP

(Dohmen et al., 2012)
* “Are you a person who is fully prepared to take risks or
do you try to avoid taking risks?”
* 10-point scales: 0 means: “completely unwilling to take
risk”;10 means: “completely willing to take risk”
* Trust from the General Social Survey GSS
* “Generally speaking, would you say that most people can
be trusted or that you can't be too careful in dealing with
people?”
* Most people can be trusted. Or
* Can’t be too careful
61
* Positive reciprocity questions from GSOEP (Dohmen, Falk, Huffman

and Sunde, 2012)
* “If someone does me a favor, I am prepared to return it.”
* “I am ready to undergo personal costs to help somebody who has helped
me before.”
* “I go out of my way to help someone who has helped me before.”
* Negative reciprocity questions from GSOEP (Dohmen, Falk, Huffman
and Sunde, 2012)
* “If I suffer a serious wrong, I will take revenge as soon as possible, no
matter what it costs.”
* “If somebody puts me in a difficult position, I will do the same to him/her.”
* “If somebody insults me, I will insult him/her back.”
* Big Five by Rammstedt and John (2007)
62
VARIOUS OTHER TOPICS
FRAMING
* When writing your instructions, you should be mindful of

how you frame the experiment.
* The framing of an experiment includes several elements :
* Wording used to qualify actions, role of participants, institutions
* How are information and actions displayed on the screen?
* Use of examples in the instructions
* Framing of decisions can inﬂuence choices (Tversky and
Kahneman, 1986; Andreoni, 1995; Burnham, McCabe,
Smith 2000, etc.)
* How can we avoid unintentional framing effects when
designing an experiment?
64
FRAMING
* Neutral framing
* “Person A sends an amount X to person B”
* Avoids everyday word associations (does it really?)
* But makes it harder to understand the rules of the game
* Subjects may differ in how they represent the game to themselves.
* Concrete framing
* “The employer pays a wage X to the employee”
* Easier to understand
* Problem (?): Associations from real life
65
FRAMING
* Example: Public Goods experiments with punishment

* “… You now have to decide, for each of the three
participants in your group, whether you wish to distribute
points to them and, if so, how many points you wish to
distribute to them. […] For each point that you allocate to a
participant, the income of this participant is reduced by 3
Taler.“ (Engel, Zhurakhovska, 2013)
* Here the word “punishment” is not used (would be a
framing).
* Also the words “cooperativeness” or “norms” are not used.
66
FRAMING
* Example : Tversky and Kahneman, 1986

* They ask subjects (also doctors) in a cancer treatment
whether they would prefer “surgery” or “radiation”
* Most importantly, they used two different framings
(Survival vs. Mortality) 90%
radiation surgery
* In this case, the frame

60%
* is the treatment!
82%
30% 56%
44%
18%
0%
survival frame morality frame
67
FRAMING
* Burnham, McCabe, Smith 2(000), vary the word of

the matched person in a Trust game
* Instead of “counterpart”, the participant one interacts
with is a “partner” (treatment 1) or an “opponent”
(treatment 2).
Trust Levels
68
FRAMING
* Generally, the experimenter would prefer a

“neutral framing” to avoid confounding factors.
* But can framing be “neutral”?
* Subjects may have heterogeneous beliefs and
understandings of the experiment.
* Defining a framing can be a tool to minimize
heterogeneity in these beliefs
* You can use framing to drive attention of subject e.g.,
to certain norms
69
ANCHORS AND FOCAL POINTS
* Another issue to be mindful of when writing

instruction is the role of anchors and focal points
* Subjects may have a tendency to rely too heavily on
the first piece of information they are offered (the
"anchor") when making decisions
* Can play a role for (wrong) usage of examples in
instructions
* Explains, why subjects tend to e.g., contribute 5, 10,
15, 20 more often than e.g., 2, 6, 9, 13
* Can play a role for order effects of treatments in
within-subject experiments
70
ANCHORS AND FOCAL POINTS
* Example : Tversky and Kahneman (1974)

* Ask subjects about the number of African countries
belonging to the UN.
* People had to spin a wheel of fortune with numbers (low
and high numbers).
* Afterwards subjects had to give an answer to the question
above.
* People showed strong anchor effects:
* People who obtained low numbers guessed a low number
of African states
* People who obtained high numbers guessed a high number
of African states
71
ANONYMITY AND REPEATED INTERACTIONS
* Typically in the experimental instructions it is written:

* “This experiment is anonymous. Nobody will find out which
other participant he or she interacts with.”
* Why is anonymity important?
* Subjects might care about reputation
* Subjects might feel an experimental demand
* What additional reasons do we have to try to
implement anonymity?
* In what kind of experiments is anonymity especially
important?
72
* Blind (standard)
* Subjects do not know, with whom they interact
* But experimenter can be seen
* Double-blind (rarely used, because complicated)
* Subjects do not know, with whom they interact
* The person who conducts the experiment, does not
know, what the experiment is about & does not know,
which choices the subject has taken
* A different person pays the subjects than the scientist
*  Experimenter demand effects can be avoided
73
* One-Shot (without repetition)

* Strong incentives for a single decision
* No strategic spillovers across periods (particularly
important if „true preferences“ are to be elicited)
* Easy and short to conduct
* Repeated interactions
* Subjects may learn
* Possible to observe dynamics, e.g., convergence to
predicted or behavioral equilibrium
* More observations
74
* Partner (groups of subjects stay together for several

periods)
* One matching group of partners results in one
independent observation
* Allows analysis of strategic considerations
* Stranger (groups are recomposed randomly)
* Similar behavior/prediction as “one-shot” but more
observations
* Perfect stranger: probability of being re-matched
with the same person is exactly zero (and subjects know
that)
75
LECTURE 4: STATISTICAL ANALYSIS Behavioral game theory
Alexia Gaudeul
OF EXPERIMENTAL DATA University of Göttingen
(Adapted from lecture slides by Claudia Keser, Holger Rau and Emmanuel Peterlé)
EXPERIMENTAL DATA
* A major advantage of experimental data is that

exogenous treatment variations and randomization
permit the identification of causal relationships
between treatment and observed behavior.
* We have a lot of control ex ante
* We can design our experiment so that our hypothesis
is easy to test
* If we have to call a statistician to analyze our data
after the experiment, then it is often like calling a
veterinary to revive a dead pet!
Behavioral Game Theory 2
EXPERIMENTAL DATA
* At the same time, experimental datasets have

specific characteristics :
* Sample size is often small.
* Variables might be discrete.
* Interaction between subjects in the laboratory or
repeated measurements create violations of
independency assumptions.

EXPERIMENTAL DATA
* Because of these specificities, the statistical analysis

of experimental data has been – and is still – widely
discussed among scholars.
* This recent field of research is referred to as
“Experimetrics“.
* Discussion on the differences in the statistical
methodologies applied to experimental and non-
experimental data can be found in :
* Bardsley et al., 2009 : “Experimental economics:
Rethinking the rules (Chapter 8)“, Princeton University Press
* Moffatt, 2015: “Experimetrics: Econometrics for
experimental economics“, Palgrave Macmillan.

INDEPENDENT OBSERVATIONS
* When designing your experimental procedure, an

important issue to consider is the number of independent
observations.
* Most of the nonparametric test only requires that
observations are independent
* One should avoid contagion of data
* You can have a lot of observation but very few
independent observations!
* This issue is particularly relevant in the case of:
* Repeated games
* Interactions between groups of participants
* Stranger matching procedure

* Example: two treatments that we would like to

compare:
Treatment 1 Treatment 2
3 sessions 3 session
20 subjects per session 20 subjects per session
Repeated : 100 periods Repeated : 100 periods
Stranger matching Stranger matching
* This experiment will provide a very large dataset

(6000 observations per treatment)
* How many independent observations are there per treatment?
* Let‘s consider some potential contagion effect in a four-player

repeated public good game. If the stranger matching is done such as
one session = one independent observation:
* Period 1

* Let‘s consider some potential contagion effect in three

players public good games. If the stranger matching is
done such as one period = one independent observation:
* Period 25

* Now let‘s consider that you divide the lab in

cohorts so that you have more independent
observation per session :
* Period 1

* Now let‘s consider that you divide the lab in

cohorts so that you have more independent
observation per session :
* Period 25

CHOOSING THE RIGHT TEST FOR YOUR DATA
Parametric tests and Non-parametric tests
Condition variable
Continuous Categorical
Two-sample t-test
Paired t-test
Correlation test ANOVA
Variable of interest
Continuous
(Pearson or Spearman) Wilcoxon-Mann-Whitney U test
Wilcoxon signed-rank test
Kruskall-Wallis
Categorical (Ordered) logit/probit regression Chi 2 test (and its variations)

CHOOSING THE RIGHT TEST FOR YOUR DATA
* Statistical analysis of the data should also consider:

* Censored data? (In the public good game, one observes a
lot of 0)
* Truncated data? (In the trust game, we do not observe the
% sent back by receivers who received nothing)
* Discrete data? (In the dictator game, senders can only
send integers)
* Duration data? (Clicking time is sometimes used to measure
emotions)
* Selection bias? (Performance in a chosen tournament)

PARAMETRIC VS. NONPARAMETRIC TESTS
* Parametric tests assume that the mean of the

variables being considered follows a specific
probability distribution.
* If these assumptions are correct, either because you
have a large sample, or because the data is “well-
behaved”, then parametric methods are more
powerful than nonparametric methods.
* That is, they are more likely to detect an effect if an effect exists.
* If these assumptions are incorrect however, parametric
tests should not be performed.

PARAMETRIC VS. NONPARAMETRIC TESTS
* Example : The Student t-test used to compare

means of two groups requires that the sample is
large or that the distribution of the variable for
each sample is at least approximately normal.
* However experimental data often deals with data
that is clustered around focal point, has bimodal
distributions, and with small sample size…
* This does not allow the researcher to fulfill such
requirement.

NONPARAMETRIC TESTS – SPEARMAN
CORRELATION TEST
* The Spearman correlation test is a test for paired data
* E.g. observations obtained from the same person.
* It is the nonparametric version of the Pearson correlation test.
* As with many nonparametric tests, it is based on ranks rather
than values.
6 ∑ 𝑑𝑑𝑖𝑖2
𝜌𝜌(𝑋𝑋; 𝑌𝑌) = 1 −
𝑛𝑛(𝑛𝑛2 − 1)
with 𝑑𝑑𝑖𝑖 the difference between the rank of 𝑋𝑋𝑖𝑖 and the rank of 𝑌𝑌𝑖𝑖 .
* The Spearman correlation test generally provides similar
results to the parametric Pearson correlation test.
* Nevertheless, it could be useful if one wants to avoid the
assumption that relationship between X and Y is linear.

CORRELATION TEST
* Example : Is there a positive relationship between the amount sent
by the same person in a dictator game and in an ultimatum game?
* 7 observations, i.e. 7 different persons playing the UG and the
DG.
Dict. Ult. Dict. Ult.
Participant d
(ECU) (ECU) (Rank) (Rank)
1 6 8 6 6 0
2 4 7 4 5 -1
3 2 6 3 4 -1
4 10 10 7 7 0
5 5 4 5 3 2
6 0 2 1 1 0
7 1 3 2 2 0
CORRELATION TEST
* On Stata the command to use Spearman
correlation test is simply “spearman”:
Rule of thumb :
• .00-.19 “very weak”
• .20-.39 “weak”
• .40-.59 “moderate”
• .60-.79 “strong”
• .80-1.0 “very strong”
* On R:
cor.test(x, y, method = "spearman", alternative = “two.sided")

NONPARAMETRIC TESTS – WILCOXON-MANN-
WHITNEY U TEST
* The Wilcoxon Mann-Whitney test (also called
Wilcoxon rank-sum test) is the nonparametric
counterpart of the t-test for two samples.
* It is used to test whether two independent samples
are drawn from the same or identical distributions.
* One can encounter this test in almost every recent
experimental study using between-subject design.
* If the distributions of the variable are far enough
from normality and if sample sizes are small, the
Wilcoxon Mann-Whitney test is much more efficient
than the t-test.

WHITNEY U TEST
* This test is also based on rank.
* If we take values from one sample and from another, put them
together and order their values, then we may obtain something like
this table:
Rank Issued from:
1 (smallest value) Sample 1
2 Sample 1
3 Sample 2
4 Sample 2
5 Sample 1
6 Sample 2
7 (largest value) Sample 1
WHITNEY U TEST
* Example:
* Suppose we want to Neutral framing Positive framing
know if a positive framing 1 8
affects donation in a 6 10
dictator game.
4 5
* We see donations
made under a neutral 3 6
and a positive framing 5 7
below (7 obs for neutral, 7 8
6 obs for positive,
different people) 2

WHITNEY U TEST
Value Rank
* Let‘s order this dataset 1 1
* The neutral framing values 2 2
and the positive framing values 3 3
are not randomly shuffled… 4 4
* Wilcoxon‘s test statistic is: 5 5.5
∑𝑟𝑟𝑟𝑟𝑟𝑟𝑘𝑘1 5 5.5
* That is, the sum of the ranks 6 7.5
of the first sample. 6 7.5
* Mann-Whitney’s U statistic is 7 9.5
𝑛𝑛 𝑛𝑛 −1 7 9.5
∑𝑟𝑟𝑟𝑟𝑟𝑟𝑘𝑘1 − 1 1
2 8 11.5
with 𝑛𝑛1 the size of the first 8 11.5
sample 10 13
WHITNEY U TEST
* On Stata the command to
run Wilcoxon Mann-Whitney
tests is “ranksum”.
* On R (“stats” package):
wilcox.test(x, y, paired=FALSE,
alternative = “two.sided")

NONPARAMETRIC TESTS – WILCOXON SIGNED-
RANK TEST
* This test is quite common in within-subject designs.
* As with the parametric paired t-test, it is used to
compare two matched samples.
* It could be for instance the decision of participants
before and after the implementation of a new
institution.
* The idea of this test is basically to count how
many increase and how many decrease the
variable has known between the first and the
second “state” of the sample.

RANK TEST
* Let‘s consider a variable 𝑥𝑥1 and a variable 𝑥𝑥2 that
take value for each observation of the same sample.
* The procedure is as follows:
* For each observation, calculate 𝑥𝑥𝑖𝑖2 − 𝑥𝑥𝑖𝑖1
* Consider the sign of the result 𝑠𝑠𝑠𝑠𝑠𝑠𝑛𝑛𝑖𝑖 and the rank 𝑅𝑅𝑖𝑖
of its absolute value.
𝑊𝑊 = ∑ 𝑠𝑠𝑠𝑠𝑠𝑠𝑛𝑛𝑖𝑖 ∙ 𝑅𝑅𝑖𝑖
i.e. it is the sum of ranks with positive signs minus the
sum of ranks with negative signs.
i.e. the difference between the ranks of the increases in
values and the ranks of the decreases in values.

RANK TEST
* Example : We want to know if participants
change their investment decision after being
exposed to a lecture on the economic crisis.
Before After Diff Sign Rank Absolute
exposition exposition value
9 5 4 - 5
6 7 1 + 2.5
8 6 2 - 4
4 4 0 0 1
10 4 6 - 6.5
7 1 6 - 6.5
6
Behavioral Game Theory 7 1 + 2.5 25
RANK TEST
* The corresponding
command on Stata is
“signrank”:
* On R (“stats” package):
wilcox.test(x, y, paired=TRUE,
alternative = “two.sided")

NONPARAMETRIC TESTS – CHI2 TEST
* The Chi2 test is used to test the dependence between two categorical
variables (generally a variable of interest and a group variable).
* It can be easily computed from a contingency table.
Group 1 Group 2
Value 1 n11 n12
Value 2 n21 n22
* We compare the observed distribution of the variable across groups

to the theoretical distribution in case of totally random distribution.
* Note: If one of the cell of the theoretical table contains less than 5
observations, then one should use Fisher‘s exact test.

* Example: Let’s consider gender differences in

tournament entry, with experienced players.
* If tournament entry is totally independent from
gender we should theoretically observe:
Does not
compete Compete Total
Female 26.66… 13.33… 40
Male 33.33… 16.66… 50
Total 60 30 90
* Let‘s assume that we observe:
Does not
compete Compete Total
Female 31 9 40
Male 29 21 50
Total 60 30 90
* We then compute a statistic which considers the differences
between the observed and the theoretical distributions:
2
2
𝑜𝑜𝑖𝑖𝑖𝑖 − 𝑡𝑡𝑖𝑖𝑖𝑖
𝜒𝜒 = �
𝑡𝑡𝑖𝑖𝑖𝑖
𝑖𝑖,𝑗𝑗
With 𝑜𝑜𝑖𝑖𝑖𝑖 the observed frequency in a cell and 𝑡𝑡𝑖𝑖𝑖𝑖 the theoretical
random frequency in the same cell
* On Stata, the Chi2 test is an option of the

“tabulate“ option:
tab female compete, chi2
compete
female 0 1 Total
0 29 21 50
1 31 9 40
Total 60 30 90
Pearson chi2(1) = 3.8025 Pr = 0.051
On R (“stats” package): wilcox.test(x, y, paired=TRUE, alternative =

“two.sided")

ECONOMETRIC REGRESSIONS
* Most of the time, simple tests are not enough to

explore experimental data.
* Some questions could be more efficiently
answered by running econometric regressions:
* Controlling ex post (e.g. demographics) to reason
ceteris paribus
* Presence of interaction effect between variables (e.g.
treatment condition and subjects‘ types)
* What are the dynamics of individual behaviors
* …

* Recommendations:
* Do not overload your regressions. A rule of thumbs is
generally to have 10-20 observations for each
covariate you include (Frank, 2002).
* Beware of multicollinearity! Including highly
correlated independent variables may lead to confusing
results.
* When including dummy variables, wisely choose the
reference and interpret by comparing to this reference.
* Rather a models that is economically consistent than a
model that controls for everything

* Binary or categorical variables of interest are quite

common in experimental data. Always consider the
right model:
* logit / probit
* ordered logit / ordered probit
* multinomial logit / multinomial probit (IIA assumption)
* Remember that the value of the coefficients
estimated in these regressions cannot directly be
interpreted.
* You can interpret signs and significance.
* To have an idea of the size of the effect from a variable,
you have to compute marginal effects.

* As the action space of the participants is finite,

many games could lead to censored data.
* This is for instance the case of the public-good game,
where participants cannot contribute less than 0 and
cannot contribute more than their endowment.
* A good way to take these boundaries into
account is to run tobit regressions.
* This is relevant as soon as the variable of interest
often takes values at the lower or upper limit.

* We want to investigate how sensitive participant
are to previous average contribution in a
repeated public good game.

* OLS regression suggest that individuals are reciprocal and
conditional contributors.
* Because of the large amount of zero, there is a chance that the
estimated coefficient is downward biased.

* Running a tobit regression allows one to rule out the downward

bias in reciprocity.
* It shows that the coefficient associated to previous contribution is
very likely greater than 1 (see 95% confidence interval).

* We sometimes want to estimate a parameter of

a model, rather than relying on statistics on the
behavior itself.
* Example: Constant Relative Risk Aversion (CRRA)
utility function
𝑦𝑦1−𝑟𝑟
𝑈𝑈 𝑦𝑦 =
(1 − 𝑟𝑟)
* The parameter r is not observable directly, it has
to be inferred from the data.

* Using data from the Holt and Laury (2002)

experiment, the researcher can conduct a
maximum-likelihood estimation of the r coefficient.
* To do so on Stata, one can use the “ml”
procedure. The likelihood has to be defined by the
user, so programming is necessary.
* See Moffat’s book for more

EXERCISES
* In exercises, we will test data for normality

* We will analyse data on the ultimatum game
and on bids in auctions.
* Please bring your computer!
Experimental Design Course 40

Behavioral game theory
LECTURE 5: MIXED STRATEGIES Alexia Gaudeul
University of Göttingen
1
BEHAVIORAL ISSUES WITH MIXED STRATEGIES
* If a game has a unique pure strategy Nash equilibrium, then
players are able to anticipate the strategies that other players
are going to play.
* If there are many pure strategy Nash equilibria, then they may
still be able to predict which one will occur (norm, focal point,
experience).
* If the game has a unique mixed strategy Nash equilibrium
(MSNE), then players know the probability the other player will
choose an action.
* If there are more than one MSNE, then which one is played
may be learned by observing the behavior of others.
2
BEHAVIORAL ISSUES WITH MIXED STRATEGIES
* However, there is no need to learn in equilibrium, as every
action obtains the same payoff if the other mixes optimally.
* This might explain why people deviate from MSNE, … however,
* This does not explain why they systematically do so  we saw an
explanation with QRE.
* This does not explain systematic patterns in the „random“ choices
people make over time.
*  deviation from the mean random behavior, and deviation from
randomness across time.
3
MIXED POPULATIONS
* Mixed strategies might be rescued by assuming that players meet
randomly over time and each player plays a pure strategy (his type).
* Over time, the proportion of each type of player would come to
correspond to the predicted mixed strategy.
* If not, assuming „types“ cannot be changed but more successful types become
more numerous, then, as one type or the other makes lower profit than the other, it
is „selected“ away (evolutionary selection).
* If types are the result of a decision by a player, then there would be a gain to
switch strategy for some people.
* However, this does not correspond to what is meant when we ask if
people play mixed-strategies.
4
AUTO-CORRELATION IN „RANDOM“ CHOICE
* Please write a sequence of 10 „0“ and „1“ as if
every time either a 0 or a 1 may appear with
equal probability.
* Now please flip a coin 10 times and write down
each draw. Denote face with 0 and number with 1.
* Compare the outcomes.
5
AUTO-CORRELATION IN „RANDOM“ CHOICE
* People generally
* switch too often,
* generate only limited numbers of long sequences with the same draw,
* tend to draw samples with the same number of 0 and 1 (if proba of
each is ½). This is due to the „representativeness heuristic“
* Brown, J. N., & Rosenthal, R. W. (1990). Testing the minimax
hypothesis: a re-examination of O'Neill's game
experiment. Econometrica, 1065-1081.
* “There is strong evidence of serial correlation in players' choices, with
several players displaying statistically significant dependence on the
past moves of their opponents.”
6
L R
AUTO-CORRELATION IN U 1,-1 -1,1
„RANDOM“ CHOICE D -1,1 1,-1
* If there is auto-correlation in my choice, then an opponent could guess
with some accuracy what I will do next.
* Example: Zero-sum game, where one player wants to coordinate -
(U,L) or (D,R) - and the other wants to „anti-coordinate“ - (U,R) or (D,L)
* Brown and Rosenthal (1990) do regressions of choices over time:
𝐽𝐽𝑖𝑖,𝑡𝑡+1 = 𝑎𝑎0 + 𝑎𝑎1 𝐽𝐽𝑖𝑖,𝑡𝑡 + 𝑎𝑎2 𝐽𝐽𝑖𝑖,𝑡𝑡−1 + 𝑏𝑏𝑜𝑜 𝐽𝐽𝑗𝑗,𝑡𝑡+1 + 𝑏𝑏1 𝐽𝐽𝑗𝑗,𝑡𝑡 + 𝑏𝑏2 𝐽𝐽𝑗𝑗,𝑡𝑡−1
* Only about 8% of players have 𝑏𝑏0 significantly different from 0.
* I.e. only about 8% of subjects seem to be able to predict the move of others
to some extent.
7
RANDOM PLAY VS. RANDOM SEQUENCES
* Asking people to generate random sequences is not the same as observing
them making random choices over time.
* Rapoport, A., & Budescu, D. V. (1992). Generation of random series in two-
person strictly competitive games. Journal of Experimental Psychology: General,
121(3), 352–363. https://doi.org/10.1037/0096-3445.121.3.352
* Three conditions:
* Play game of matching pennies over time (150 repetitions!)
* Generate random sequence for game of matching pennies against opponent.
* Try to replicate draws from a coin.
* People are better able to play randomly in the first condition.
* Maybe because cognitive load makes them forget what they played and other played
in previous repetitions of the game?
8
USING RANDOMIZING DEVICES
* If people cannot randomize well, then what happens if
we give them access to a randomizing device? Do they
make use of it, and do they use it well?
* Bloomfield, R. (1994). Learning a mixed strategy equilibrium in
the laboratory. Journal of Economic Behavior &
Organization, 25(3), 411-436.
* In that experiment, people choose how many times to play each action, are matched
with someone else, and then get their expected payoff given the other‘s mixed strategy
and their own.
* Issue: Would you let such a device play for you? Would
you not want to keep control?
9
THEORIES OF LEARNING IN GAMES WITH MSE
* How are people influenced by past events and does
this teach them to randomize correctly?
* Erev, I., & Roth, A. E. (1998). Predicting How People Play Games:
Reinforcement Learning in Experimental Games with Unique, Mixed Strategy
Equilibria. The American Economic Review, 88(4), 848–881.
* Several theories of learning, from simple to
complicated.
* Tested on data from a range of papers where people
played games with mixed strategies over many periods.
10
* Compare what is played with MSNE.
* Compare what is played with theories of learning.
11
* Basic reinforcement: If gets a high payoff from an
action, then I will be more likely to repeat that action
next period.
* How much more likely depends on how much more this payoff is than
the minimum in the game.
* Propensity to play an action is function of sum of past reinforcements
for that action in the past.
12
* Extension of basic theory with two more parameters:
* Decay of past experience  recent experience impact behavior
more.
* Experimentation  positive experience with one action also makes
„similar“ actions more likely.
* Final extension with one more parameter
* Fictitious play  choose the strategy that would have done best
given what the other player did in the past (i.e. frequency of play of one
action or the other).
13
EMPIRICAL TESTS IN GAMES WITH HIGH STAKES
* Tennis playing:
* Walker, M., & Wooders, J. (2001). Minimax play at
Wimbledon. The American Economic Review, 91(5), 1521-
1538.
https://www.aeaweb.org/articles?id=10.1257/aer.91.5.1
521
* Football penalties
* Palacios-Huerta “Professionals Play Minimax” Review of
Economic Studies, vol. 70(2), April 2003, pp. 395-415.
https://doi.org/10.1111/1467-937X.00249
14
LECTURE 5: SOCIAL PREFERENCES Alexia Gaudeul
(Partly adapted from lecture slides by Claudia Keser, Holger Rau and Emmanuel Peterlé)
OUTLINE
* Different explanations for behavior in the Ultimatum
game.
* Strategic behavior, fairness, inequality aversion,
reciprocity?
* A few games to illustrate the impact of reciprocity and
inequality aversion.
* Elicitation of inequality aversion parameters.
* Elicitation of beliefs to check for strategic motivations.
ULTIMATUM GAME (GÜTH, SCHMITTBERGER, AND
SCHWARZE, 1982)
* Simple two-stage bargaining game:
* First mover (proposer) has 20 ECU.
* She has to decide on how much to offer to the second mover
(responder).
* First mover can send 𝑠𝑠 = {0, 1, 2, … , 20} to the second mover.
* Second mover is informed of the proposal and can accept or
reject.
* If second mover accepts: Each player earns the proposed split
* If second mover rejects: Both players earn zero.
ULTIMATUM GAME
* The sub-game perfect Nash equilibrium is that the second mover
should accept all offers greater or equal to1
* The first mover anticipates this and sends the lowest amount
possible, i.e. 𝑠𝑠 = 1.
* However, experimental results show that players send more than 1.
* Most of the low offers (𝑠𝑠 < 40%) are rejected by second movers
* The latter finding was interpreted by Fehr and Schmidt (1999) as
second movers being inequality averse.
* Fehr, E., & Schmidt, K. M. (1999). A theory of fairness, competition, and
cooperation. Quarterly Journal of Economics, 114(3), 817–868.
FEHR AND SCHMIDT (1999)
* Fehr and Schmidt (1999) established a model which
involves both subjects‘ (i) selfish inequity concerns (alpha)
and their (ii) altruistic concerns (beta):
* 𝛼𝛼 measures subjects‘ utility loss resulting from
disadvantageous payoff differences
* 𝛽𝛽 measures subjects‘ utility loss resulting from advantageous
payoff differences
𝑈𝑈 𝑚𝑚𝑚𝑚, 𝑦𝑦𝑦𝑦𝑦𝑦 = 𝑚𝑚𝑚𝑚 − 𝛼𝛼𝛼𝛼𝛼 𝑦𝑦𝑦𝑦𝑦𝑦 − 𝑚𝑚𝑚𝑚, 0 − 𝛽𝛽max 𝑚𝑚𝑚𝑚 − 𝑦𝑦𝑦𝑦𝑦𝑦, 0
• In blue is the utility of an egoist
 does not depend on the
payoff of the other.
• In black is the case of a person
who is inequality averse 
Utility of a given payoff is
maximum when there is
equality.
• This person dislikes
disadvantage in payoff more
than advantage in payoff
(𝛼𝛼 > 𝛽𝛽)
* The model of inequality aversion can be re-written
as follows:
* 𝑈𝑈 𝑚𝑚𝑚𝑚, 𝑦𝑦𝑦𝑦𝑦𝑦 = (1 + 𝛼𝛼)𝑚𝑚𝑚𝑚 − 𝛼𝛼𝑦𝑦𝑦𝑦𝑦𝑦 if 𝑦𝑦𝑦𝑦𝑦𝑦 − 𝑚𝑚𝑚𝑚 > 0
* 𝑈𝑈 𝑚𝑚𝑚𝑚, 𝑦𝑦𝑦𝑦𝑦𝑦 = 1 − 𝛽𝛽 𝑚𝑚𝑚𝑚 + 𝛽𝛽𝑦𝑦𝑦𝑦𝑦𝑦 if 𝑦𝑦𝑦𝑦𝑦𝑦 − 𝑚𝑚𝑚𝑚 < 0
* So the model is equivalent to a model of altruism
that depends on relative position: altruistic if ahead
of others, mean/competitive if behind others.
ULTIMATUM GAME
* Beyond inequality aversion, rejection of „bad“ offers could also
be negative reciprocity, i.e. I reciprocate bad offers with bad offers.
* Fehr, E., & Gächter, S. (2000). Fairness and Retaliation: The Economics of
Reciprocity. Journal of Economic Perspectives, 14(3), 159–181.
* As for first mover, are they being altruistic or do they anticipate
inequality aversion of the second mover?
* This can be answered in part with the dictator game (next slide).
* This can also be answered by eliciting their beliefs (more on this later)
DICTATOR GAME (KAHNEMAN, KNETSCH, AND
THALER, 1986)
* As in UG, the first mover gets 20€ and can send any of s =
{0, 1, 2, . . , 20}
* However, second mover has no choice, i.e., she has to accept anything
* Finding: FM‘s send on average around 20%.
* Amount sent can be interpreted as altruistic behavior.
* Anecdote: Kahneman & Tversky designed an UG and then found out Güth
et al. already did it  they went one step simpler with the DG!
* Difference between 40% sent in UG and 20% sent in DG reflect
strategic giving, dependent on belief about proba of rejection by SM.
TRUST GAME (BERG, DICKHAUT & MCCABE, 1995)
* Berg, J., Dickhaut, J., & McCabe, K. (1995). Trust, Reciprocity, and
Social History. Games and Economic Behavior, 10(1), 122–142.
https://doi.org/10.1006/game.1995.1027
* FM gets 10€, chooses how much to send to SM.
* Whatever is sent is tripled and given to SM.
* SM then decides how much to send back.
* If FM sends 𝑚𝑚 and SM sends proportion 𝑘𝑘 back then payoffs are:
* FM: 10 − 𝑚𝑚 + 3𝑘𝑘𝑘𝑘
* SM: 3 1 − 𝑘𝑘 𝑚𝑚
TRUST GAME
* Basically, this is a reverse DG: The FM decides how
much money the SM will have to share with FM as a
dictator.
* The game also introduces efficiency concerns:
* The more the FM sends to the SM, the more total welfare
is generated.
* Subgame perfect equilibrium is such that 𝑘𝑘 = 0 and
𝑚𝑚 = 0.
TRUST GAME
* 32 pairs of subjects.
* No social history, i.e.
no info about previous
play of the game.
* Some reciprocation,
about 30% of what is
generated is sent back.
* This is less than the
1/3 that would make
the investment break-
even for the first move.
TRUST GAME
* 28 pairs of subjects.
* Social history, i.e. info about
previous play of the game by
other players (previous graph).
* We would expect less amount
sent, and retaliation by less
payback.
* But we see increase in payback
and amount sent does not change.
* Tighter link between amount
sent and sent back.
ELICITATION OF FAIRNESS PREFERENCES
* Blanco et al. (2011) use modified versions of the Ultimatum
Game and Dictator game to elicit subjects‘ fairness behavior.
* Blanco, M., Engelmann, D., & Normann, H. T. (2011). A within-
subject analysis of other-regarding preferences. Games and Economic
Behavior, 72(2), 321–338.
https://doi.org/10.1016/j.geb.2010.09.008
* The same subjects have to take part in both games (within-
subject design).
* Afterwards Blanco et al. (2011) calculate for all subjects a
joint distribution of their fairness parameters.
* In their experiments they asked subjects to act as Person A
and Person B in a modified Ultimatum Game (UG).
* When subjects act as Person A they decide as a proposer in an
UG.
* When subjects act as Person B they decide as a responder in an
UG.
* Person A’s decision is not of importance as the goal is to
elicit subjects’ 𝛼𝛼.
* However, a subject’s decision as second mover (Person B) is
crucial.
* All subjects first decide as proposer (Person A) in the
UG.
* Decision as Person A.
* „How many Euros (0-20) would you offer Person B?“
* Afterwards they have to act as responder (Person B).
* Here, they have to state which first-mover offer they would
accept.
* From the Fehr and Schmidt (1999) model it follows that
a second mover will be indifferent in accepting/rejecting
an offer 𝑚𝑚𝑚𝑚 if 𝑚𝑚𝑚𝑚 − 𝛼𝛼𝑖𝑖 𝑦𝑦𝑦𝑦𝑦𝑦 − 𝑚𝑚𝑚𝑚 = 0, that is, if
𝛼𝛼𝑖𝑖 = 𝑚𝑚𝑚𝑚/ 𝑦𝑦𝑦𝑦𝑦𝑦 − 𝑚𝑚𝑚𝑚 .
* Blanco et al. (2010) take the mid-point of the first
switching point in the table as the point for indifference.
* Thus, if the subject switches in line 9 then
7.5
𝛼𝛼𝑖𝑖 = = 1.5
12.5 − 7.5
* Subjects’ 𝛽𝛽 is elicited with a Modified Dictator Game (MDG)
* Subjects are presented to 21 distribution choices of a dictator
* Have to take 21 decisions
* Subjects always have to decide between a selfish choice (20;0) or
an equal choice (0;0), (1;1), (2;2) ... (20;20) in increasing order.
* Measures how long a subject choses selfish choices (left choice)
* Subjects who switch early from left to right have high 𝛽𝛽
* Late subjects have low 𝛽𝛽
PLAYER A’s
decision
in the MDG
(example)
In example:
Player A prefers
(8;8) over (20;0)
Experimental Design Course 20

* From the Fehr and Schmidt (1999) model it follows that
a dictator will be indifferent between (20;0) and the
𝑥𝑥𝑖𝑖
egalitarian distribution 𝑥𝑥𝑖𝑖 if 𝛽𝛽𝑖𝑖 = 1 − .
20
′ ′
* Blanco et al. (2010) set 𝑥𝑥𝑖𝑖 = − 0.5 where
𝑥𝑥𝑖𝑖 𝑥𝑥𝑖𝑖 is the
first accepted egalitarian offer).
* Thus, in our example the subject has
8 − 0.5
𝛽𝛽𝑖𝑖 = 1– = 0.625
20
We confirm here that for
most people, 𝛼𝛼 is more than
𝛽𝛽 (33 points vs. 20), and that
few people are purely
egoistic (points such that
𝛼𝛼 = 𝛽𝛽 = 0.
Furthermore, values of 𝛼𝛼 are
higher than values of 𝛽𝛽.
BELIEF ELICITATION
* Important mechanism to understand all processes and
the strategic behavior of all players in experiments
* Typically the belief elicitation process is incentivized by
monetary rewards
* Examples
* Subjects’ beliefs about other players’ contribution levels in
public-good games
* First movers’ beliefs about second movers’ trustworthiness in
the investment game.
BELIEF ELICITATION
* But how to incentivize players’ beliefs?
* The quadratic-scoring rule provides an incentive compatible
measure to elicit subjects’ beliefs.
* Subjects earn more money when making more precise
guesses.
𝜋𝜋 = 𝜋𝜋max − 𝑝𝑝 𝑡𝑡 − 𝑔𝑔 2
𝑝𝑝=punishment parameter which is subtracted
𝑡𝑡=true value
𝑔𝑔=guess
BELIEF ELICITATION
* Example:
* A first mover is endowed with 5€ in a trust game
* The invested amount is doubled
* The first mover invests 5€
* The experimenter elicits the FM’s belief of the SM’s return
level
* Return level in the interval: {0, 10}
* Parameters used: 𝜋𝜋𝑚𝑚𝑚𝑚𝑚𝑚 = 250 cents and 𝑝𝑝 = 2.5.
BELIEF ELICITATION
payoffs
decreasing
correct
guess
BELIEF ELICITATION
* Issues include:
* Hedging: If subject is not risk-neutral, then he may not
report true belief to hedge against event that does not fit
belief.
* E.g. I give 4€ in the trust game while expecting 40% back, but I say I expect
20% back so I win if 40% is sent back and I also win if 20% is sent back.
* „Solution“: Elicit risk aversion, correct payoffs in euros 𝑥𝑥 to
change them in „utils“ (𝑈𝑈(𝑥𝑥)).
* Pay either for belief or for action.
BELIEF ELICITATION
* Point distribution: Forces people to express precise
beliefs while actual beliefs may be a distribution:
* E.g. I believe that I will get 40% back with 50% proba,
20% with 25% proba and 60% with 25 proba.
* „Solution“: Elicit belief intervals, let people choose
distribution of beliefs, elicit probability of subsets of
outcomes.
LECTURE 6: AUCTIONS AND THE Behavioral game theory
Alexia Gaudeul
WINNER’S CURSE University of Göttingen
Partially inspired by lecture notes of Oliver Kirchkamp

1
AUCTIONS
* Auctions are systems and procedures developed
to organize the bidding of buyers as they compete
to buy a product.
* One seller, many buyers  auction
* One seller, one buyer  bargaining
* Many sellers, one buyer  procurement auction
* Many sellers, many buyers  competitive market
2
AUCTIONS
* Auctions are relevant in a large part of the economy:
* Not only for used products or art (eBay, Sotheby‘s)
* Indeed, a large range of economic activities can be modeled as
auctions.
* See Klemperer, P. (2000). Why Every Economist Should Learn Some Auction Theory
(Microeconomics). EconWPA. Retrieved from
https://econpapers.repec.org/paper/wpawuwpmi/0004009.htm
* Proper design of auctions can be vital to prevent collusion
among bidders, encourage bidders to participate, all in the name
of maximizing revenue for the seller.
* Klemperer, P. (2002). What really matters in auction design. Journal of economic
perspectives, 16(1), 169-189.
* From this point of view, auction design often relies on prior
experimental testing.
3
AUCTIONS
* Auctions can be classified depending on how the good is valued and
what information people have about this value:
* Private values  each bidder has his own value for the good, uncorrelated
with others, e.g.
* Common values  the good has the same value for all, e.g. bidding for oil
fields.
* In practice, it is always a bit in between  interdependent value auctions.
* Before examining how auctions work in practice, we need to
understand the theory.
* Second price sealed bid auction
* First price sealed bid auction
4
SECOND PRICE SEALED BID AUCTION
* A second price sealed bid auction is such that buyers secretly
give their bid to the seller.
* The seller sells the good to the highest bidder at the price
indicated by the second highest bidder (second price = second
highest price).
* Also called Vickrey auction.
* Example with two potential buyers:
* Two buyers, 𝑖𝑖 and 𝑗𝑗,  submit sealed bids 𝑏𝑏𝑖𝑖 and 𝑏𝑏𝑗𝑗 to a seller.
* The highest bidder wins the object, and pays the second highest bid
to the seller.
5
* The object is worth 𝑣𝑣𝑖𝑖 to buyer 𝑖𝑖 and 𝑣𝑣𝑗𝑗 to buyer 𝑗𝑗.
* 𝑖𝑖 knows 𝑣𝑣𝑖𝑖 but not 𝑣𝑣𝑗𝑗,  and 𝑗𝑗 knows 𝑣𝑣𝑗𝑗 but not 𝑣𝑣𝑖𝑖 .
* The two values are independent.
* Payoffs can be represented as follows:
𝑢𝑢𝑖𝑖 =  0  𝑖𝑖𝑖𝑖 𝑏𝑏𝑖𝑖   <   𝑏𝑏𝑗𝑗
𝑣𝑣𝑖𝑖   −   𝑏𝑏𝑗𝑗
𝑢𝑢𝑖𝑖 =  𝑖𝑖𝑖𝑖 𝑏𝑏𝑖𝑖   =   𝑏𝑏𝑗𝑗
2
𝑢𝑢𝑖𝑖 = 𝑣𝑣𝑖𝑖   −   𝑏𝑏𝑗𝑗 𝑖𝑖𝑖𝑖 𝑏𝑏𝑖𝑖   >   𝑏𝑏𝑗𝑗
6
* Suppose that 𝑗𝑗 bids 𝑣𝑣𝑗𝑗 .
* Suppose 𝒊𝒊 makes a bid 𝒃𝒃𝒊𝒊 > 𝒗𝒗𝒊𝒊 .
* Then 𝑖𝑖‘s expected payoff is:
* If 𝑏𝑏𝑖𝑖 < 𝑣𝑣𝑗𝑗 : payoff is 0
* If 𝑏𝑏𝑖𝑖 > 𝑣𝑣𝑗𝑗 : payoff is (𝑣𝑣𝑖𝑖 − 𝑣𝑣𝑗𝑗 ).
* If 𝑣𝑣𝑖𝑖 > 𝑣𝑣𝑗𝑗 , then all is fine.
* But if 𝑣𝑣𝑖𝑖 < 𝑣𝑣𝑗𝑗 , then the payoff is negative.
7
* Suppose 𝒊𝒊 makes a bid 𝒃𝒃𝒊𝒊 < 𝒗𝒗𝒊𝒊 .
* Then 𝑖𝑖‘s expected payoff is:
* If 𝑏𝑏𝑖𝑖 < 𝑣𝑣𝑗𝑗 : payoff is 0
* If 𝑏𝑏𝑖𝑖 > 𝑣𝑣𝑗𝑗 : payoff is (𝑣𝑣𝑖𝑖 − 𝑣𝑣𝑗𝑗 ).
* If 𝑣𝑣𝑖𝑖 > 𝑏𝑏𝑖𝑖 > 𝑣𝑣𝑗𝑗 , then I get the good and I still pay 𝑣𝑣𝑗𝑗 .
* But if 𝑣𝑣𝑖𝑖 > 𝑣𝑣𝑗𝑗 > 𝑏𝑏𝑖𝑖 , then I do not get the good and could have
gotten it if I had bid more.
* Therefore, I should bid 𝑏𝑏𝑖𝑖 = 𝑣𝑣𝑖𝑖 .

8
ENGLISH AUCTIONS
* In practice, the Vickrey auction is rarely used, but other mechanisms can be
equivalent, e.g. the English auction (open-outcry ascending dynamic auction).
* Bids are made publicly by the bidders („open“).
* Only bids higher than the highest bid are accepted.
* After a pre-defined time period, the auction ends and the highest bidder
pays his bid.
* This process, under some conditions (values are independent), is equivalent to
a sealed-bid second-price auction („Vickrey auction“)
* The winner gets the good at the maximum price that competitors are willing to pay.
* This is less than what the winner himself is ready to pay.
9
ENGLISH AUCTIONS
* Kagel, J. H., Harstad, R. M., & Levin, D. (1987). Information
impact and allocation rules in auctions with affiliated private
values: A laboratory study. Econometrica: Journal of the
Econometric Society, 1275-1304.
* People bid more vs. predicted bids in the second price auction
than in English auctions.
* Because rule more difficult to understand?
* Because overbidding appears less costly since it does not impact
directly price paid? (you pay second price).
* Conclude that “English auction is ideal for producing observational
learning”.
10
FIRST PRICE SEALED BID AUCTION
* As the name indicates, a first price sealed bid auction is
such that buyers secretly give their bid to the seller, and the
seller sells the good to the highest bidder at the price
indicated by this highest bidder (first price = highest price).
* Suppose the object is worth 𝑣𝑣𝑖𝑖 to buyer 𝑖𝑖 and 𝑣𝑣𝑗𝑗 to buyer
𝑗𝑗. 𝑖𝑖 knows 𝑣𝑣𝑖𝑖 but not 𝑣𝑣𝑗𝑗,  and 𝑗𝑗 knows 𝑣𝑣𝑗𝑗 but not 𝑣𝑣𝑖𝑖 .
* The two values are independent.
* 𝑖𝑖 believes 𝑣𝑣𝑗𝑗 is distributed uniformly over 0,  1 and 𝑗𝑗
believes 𝑣𝑣𝑖𝑖 is distributed uniformly over [0,  1].
11
* Payoffs can be represented as follows:
𝑢𝑢𝑖𝑖 =  0  𝑖𝑖𝑖𝑖 𝑏𝑏𝑖𝑖 < 𝑏𝑏𝑗𝑗
𝑣𝑣𝑖𝑖   −   𝑏𝑏𝑖𝑖
𝑢𝑢𝑖𝑖 =  𝑖𝑖𝑖𝑖 𝑏𝑏𝑖𝑖 = 𝑏𝑏𝑗𝑗
2
𝑢𝑢𝑖𝑖 = 𝑣𝑣𝑖𝑖 − 𝑏𝑏𝑖𝑖 𝑖𝑖𝑖𝑖 𝑏𝑏𝑖𝑖 > 𝑏𝑏𝑗𝑗
12
* Suppose 𝑏𝑏𝑖𝑖 (𝑣𝑣𝑖𝑖 )   =  𝛼𝛼  +  𝛽𝛽𝑣𝑣𝑖𝑖 .
* Then expected payoff is
𝐸𝐸𝑢𝑢𝑗𝑗 = Pr 𝑏𝑏𝑗𝑗 ≥ 𝛼𝛼 + 𝛽𝛽𝑣𝑣𝑖𝑖 𝑣𝑣𝑗𝑗   −   𝑏𝑏𝑗𝑗   = 
𝑏𝑏𝑗𝑗  − 𝛼𝛼 𝑏𝑏𝑗𝑗  − 𝛼𝛼
Pr(   ≥   𝑣𝑣𝑖𝑖 )(𝑣𝑣𝑗𝑗   −   𝑏𝑏𝑗𝑗 ) =   𝑣𝑣𝑗𝑗   −   𝑏𝑏𝑗𝑗
𝛽𝛽 𝛽𝛽
𝑣𝑣𝑗𝑗  + 𝛼𝛼
* The maximum is for 𝑏𝑏𝑗𝑗   =   .
2
13
* Suppose j indeed chooses 𝑏𝑏𝑗𝑗   =   (𝑣𝑣𝑗𝑗   +  𝛼𝛼)/2. Then  
𝑣𝑣𝑗𝑗  + 𝛼𝛼
* 𝐸𝐸𝑢𝑢𝑖𝑖 = Pr 𝑏𝑏𝑖𝑖   ≥   𝑣𝑣𝑖𝑖   −   𝑏𝑏𝑖𝑖 =
2
 Pr 2𝑏𝑏𝑖𝑖   −  𝛼𝛼  ≥   𝑣𝑣𝑗𝑗 𝑣𝑣𝑖𝑖   −   𝑏𝑏𝑖𝑖 =   (2𝑏𝑏𝑖𝑖   −  𝛼𝛼)(𝑣𝑣𝑖𝑖   −   𝑏𝑏𝑖𝑖 ).
* This 𝛼𝛼 + 2𝑣𝑣
is a concave function that attains its maximum for
𝑖𝑖
𝑏𝑏𝑖𝑖   =   .
4
* Combining the two 1
equations for 𝑏𝑏𝑖𝑖 and 𝑏𝑏𝑗𝑗 , we get
𝛼𝛼  =  0 and 𝛽𝛽  =   .
2
* Each bidder bids half his/her own valuation for the good.
14
Cox, James C., Roberson, Bruce, and Smith, Vernon L. “Theory
and Behavior of Single Object Auctions”. In: Vernon L. Smith,
ed., Research in Experimental Economics, Vol. 2. Greenwich,
DUTCH AUCTION CT: JAI Press, 1982
* With i.i.d. valuations, the first price sealed bid auction is equivalent to
the Dutch descending price auction.
* Different from the English auction in that you do not know the bids made by
the other participants!
* This means there is less opportunity for „observational learning“ (learning from
the experience of others).
* However, experimental subjects tend to bid more in first price auctions
than in descending price Dutch auction (Cox, Roberson, Smith, 1982).
* Utility of suspense of waiting?
* False updating of valuation as, when price decreases, this indicates that others
have low valuation for the good?
15
TESTING REVENUE EQUIVALENCE
* With risk neutral bidders and
independent values for the good, the
expected price obtained for the
good sold is the same with all
standard auctions, that is, auctions
such that the bidders with the highest
bid obtains the object.
* Vickrey, W. (1961).
Counterspeculation, auctions, and
competitive sealed tenders. The Journal
of finance, 16(1), 8-37.
* In practice…
(From Lucking-Reiley, AER, 1999) 16

TESTING REVENUE EQUIVALENCE: FIELD
EXPERIMENTS
* Lucking-Reiley, D. (1999). Using Field Experiments to
Test Equivalence Between Auction Formats: Magic on the
Internet. American Economic Review, 89(5), 1063–1080.
https://doi.org/10.1257/aer.89.5.1063
* “the Dutch auction produces 30-percent higher revenues than the first-
price auction format, a violation of the theoretical prediction and a
reversal of previous laboratory results, and that the English and
second-price formats produce roughly equivalent revenues”.
17
THE WINNER’S CURSE
* We looked up to now into models with independent
private values (you know the value you assign to the good
and it does not depend on how others value the good).
* What happens in models with common values (the value
you assign to the good is the same as for the other bidders,
but you don’t know what it is)?
* The value of the good to be auctioned is the same for
you and your competitor (common value, for example the
right to explore for oil reserves in a certain geographical
area).
18
* You both don’t know what the value is.
* Then it is quite likely that if you win, this is because you were
too optimistic about what the good was worth.
* Winning a bid against well-informed buyers is a bad sign.
* Winner’s curse: if you win, you lose (i.e. you paid too much).
* Unlike in a context with independent private values, the revenue
equivalence theorem does not hold  how much you receive as a
seller depends on how you design the auction.
* For example, you get less revenue with a first price auction than
with a second price auction.
19
* Formally, good with value 𝑣𝑣 for all bidders, they
know
−
that +value was drawn from a distribution between
𝑣𝑣 and 𝑣𝑣 .
* Bidders receive signal 𝑠𝑠𝑖𝑖 = 𝑣𝑣 + 𝑠𝑠 with s ∈ [−𝑒𝑒, 𝑒𝑒]
symmetrically distributed around 0.
* The highest bidder gets 𝑣𝑣 − 𝑏𝑏, with 𝑏𝑏 his bid.
* Taking into account the winner’s curse, bidders should
bid slightly more than 𝑠𝑠𝑖𝑖 − 𝑒𝑒, i.e. a bit more than the
worse possible value of the good given their signal.
20
THE WINNER’S CURSE: EXPERIMENTS
* Bazerman, M. H., & Samuelson, W. F. (1983). I won
the auction but don’t want the prize. Journal of Conflict
Resolution, 27(4), 618–634.
* “the average auction resulted in a loss of $2 to the
winning bidder” (winner paid $10 for a good of value $8).
* “two factors are shown to (increase) the incidence and
magnitude of the winner's curse: (1) the degree of
uncertainty concerning the value of the item up for bid and
(2) the number of competing bidders”.
* We tested this in the lab last Wednesday.
21
THE WINNER‘S CURSE: EXPLANATIONS
* Utility from winning?
* Taste for action?
*  in some experiments, to test this, people are given an
alternative action other than bidding.
* Failure to correct bids for the fact that having the
highest signal means the signal is probably an
overestimate?
* Difficulty in reasoning about possible events in the future
and how to correct behavior to account for all possibilities.
22
APPLICATION: THE WALLET GAME
* You and others put your wallets on a table.
* You know how much there is in your wallet but not
how much is in others’.
* You are asked how much you are willing to bid to
have the money in all the wallets.
* We will look at the optimal bid if the auction is
second price or first price.
23
* N players or bidders, 𝑗𝑗 = 1, … 𝑁𝑁
* You know signal 𝑠𝑠𝑖𝑖 about the value of your own good.
* Utility of the good is 𝑢𝑢 𝑠𝑠𝑖𝑖 , 𝑆𝑆−𝑖𝑖 = ∑ 𝑠𝑠𝑗𝑗 = 𝑉𝑉
* Denote 𝑡𝑡𝑖𝑖 = max 𝑠𝑠𝑗𝑗 .
𝑗𝑗≠𝑖𝑖
* For simplicity, assume signals 𝑠𝑠𝑗𝑗 , which are values in
each wallet, are drawn from a uniform distribution over
[0, 𝑣𝑣], same for all players, independently drawn across
players.
24
𝑣𝑣
* Naïve bidding: 𝐸𝐸[𝑉𝑉/𝑠𝑠𝑖𝑖 ] = 𝑠𝑠𝑖𝑖 + 𝑁𝑁 − 1 :
2
* You bid what is in your wallet, plus the sum of the expected value of what is in others’
wallets.
* Assume that the bidder with the highest signal is the one who gets the good.
* Then value of the good conditional on winning is 𝐸𝐸[𝑉𝑉|𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 > 𝑡𝑡𝑖𝑖 ] and this is less than
𝐸𝐸[𝑉𝑉|𝑠𝑠𝑖𝑖 ] because given that I won, it must be that all signals
𝑠𝑠𝑖𝑖 of other players were less
than mine, so the sum of their value is at most 𝑁𝑁 − 1
2
* (The signals of others are uniformly distributed between 0 and 𝑠𝑠𝑖𝑖 ).
* Expected value of bidding 𝑠𝑠𝑖𝑖 and getting the good is thus:
𝑁𝑁 − 1 𝑠𝑠𝑖𝑖 𝑁𝑁 + 1 𝑠𝑠𝑖𝑖
𝐸𝐸 𝑉𝑉 𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 > 𝑡𝑡𝑖𝑖 = 𝑠𝑠𝑖𝑖 + =
2 2
25
* We now look at the optimal strategy in a second price auction.
* Suppose that the optimal strategy is 𝑏𝑏 ∗ 𝑠𝑠 , i.e. people bid 𝑏𝑏 ∗ 𝑠𝑠 if they get signal s.
* If I win, then the price I pay is 𝑏𝑏 ∗ (𝑡𝑡𝑖𝑖 ), the bid of the second highest bidder.
* Expected value conditional on bidding b is
𝐸𝐸 𝑉𝑉 − 𝑏𝑏 ∗ 𝑡𝑡𝑖𝑖 × 1 𝑏𝑏 > 𝑏𝑏 ∗ 𝑡𝑡𝑖𝑖 𝑠𝑠𝑖𝑖
E 𝑉𝑉 − 𝑏𝑏 ∗ 𝑡𝑡𝑖𝑖 × 1 𝑠𝑠𝑖𝑖 > 𝑡𝑡𝑖𝑖 𝑠𝑠𝑖𝑖
𝑠𝑠𝑖𝑖
� 𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑡𝑡𝑖𝑖 − 𝑏𝑏 ∗ 𝑡𝑡𝑖𝑖 𝑓𝑓 𝑡𝑡𝑖𝑖 𝑠𝑠𝑖𝑖 𝑑𝑑𝑡𝑡𝑖𝑖
0
𝑠𝑠𝑖𝑖 𝑁𝑁−1
With 𝐹𝐹 𝑡𝑡𝑖𝑖 𝑠𝑠𝑖𝑖 = ∏ Pr 𝑠𝑠𝑗𝑗 < 𝑠𝑠𝑖𝑖 = the probability that all other signals are less than
𝑣𝑣
𝑠𝑠𝑖𝑖 .
26
In equilibrium, bid 𝑏𝑏 = 𝑏𝑏 ∗ 𝑠𝑠𝑖𝑖 so 𝑠𝑠𝑖𝑖 = 𝑏𝑏 ∗ −1 (𝑏𝑏)
So I want to maximize
𝑏𝑏∗ −1 (𝑏𝑏)
� 𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑡𝑡𝑖𝑖 − 𝑏𝑏 ∗ 𝑡𝑡𝑖𝑖 𝑓𝑓 𝑡𝑡𝑖𝑖 𝑠𝑠𝑖𝑖 𝑑𝑑𝑡𝑡𝑖𝑖
0
This is maximized when the derivative is 0. This means when
𝑣𝑣(𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 ) − 𝑏𝑏 ∗ (𝑠𝑠𝑖𝑖 ) = 0
i.e value when the maximum signal of other players is equal to my signal.
∗
𝑁𝑁 − 2 𝑠𝑠𝑖𝑖 𝑁𝑁 + 2 𝑠𝑠𝑖𝑖
𝑏𝑏 𝑠𝑠𝑖𝑖 = 𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 = 𝑠𝑠𝑖𝑖 + 𝑠𝑠𝑖𝑖 + =
2 2
27
* We now look at the optimal strategy in a first price auction.
* If I bid 𝑏𝑏 in a first price auction and I win, then the price I pay is 𝑏𝑏.
* Therefore (cf. second price auction) I want to maximize
𝑏𝑏∗ −1 (𝑏𝑏)
� 𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑡𝑡𝑖𝑖 − 𝑏𝑏 𝑓𝑓 𝑡𝑡𝑖𝑖 𝑠𝑠𝑖𝑖 𝑑𝑑𝑡𝑡𝑖𝑖
0
* The maximum is reached when the derivative wrt 𝑏𝑏 is equal to 0.
𝑏𝑏∗ −1 𝑏𝑏
1
−� 𝑓𝑓 𝑡𝑡𝑖𝑖 𝑠𝑠𝑖𝑖 𝑑𝑑𝑡𝑡𝑖𝑖 + ∗′ 𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 − 𝑏𝑏 𝑓𝑓 𝑠𝑠𝑖𝑖 𝑠𝑠𝑖𝑖 = 0
0 𝑏𝑏 𝑠𝑠𝑖𝑖
1
−𝐹𝐹 𝑠𝑠𝑖𝑖 𝑠𝑠𝑖𝑖 + ∗′ 𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 − 𝑏𝑏 𝑓𝑓 𝑠𝑠𝑖𝑖 𝑠𝑠𝑖𝑖 = 0
𝑏𝑏 𝑠𝑠𝑖𝑖
28
* So 𝑏𝑏 = 𝑏𝑏 ∗ 𝑠𝑠𝑖𝑖 is such that
𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 − 𝑏𝑏 ∗ 𝑠𝑠𝑖𝑖 𝑓𝑓 𝑠𝑠𝑖𝑖 𝑠𝑠𝑖𝑖
∗′
=1
𝑏𝑏 𝑠𝑠𝑖𝑖 𝐹𝐹(𝑠𝑠𝑖𝑖 |𝑠𝑠𝑖𝑖 )
i.e.
∗′ ∗
𝑓𝑓 𝑠𝑠𝑖𝑖 𝑠𝑠𝑖𝑖
𝑏𝑏 𝑠𝑠𝑖𝑖 = (𝑣𝑣 𝑠𝑠𝑖𝑖 , 𝑠𝑠𝑖𝑖 − 𝑏𝑏 𝑠𝑠𝑖𝑖 )
𝐹𝐹(𝑠𝑠𝑖𝑖 |𝑠𝑠𝑖𝑖 )
* This is a first order linear non-homogeneous differential equation of the
form
𝑑𝑑𝑑𝑑 𝑓𝑓(𝑥𝑥|𝑥𝑥) 𝑓𝑓(𝑥𝑥|𝑥𝑥)
− 𝑃𝑃 𝑥𝑥 𝑦𝑦 = 𝑄𝑄 𝑥𝑥 with 𝑄𝑄 𝑥𝑥 = 𝑣𝑣 𝑥𝑥, 𝑥𝑥 and 𝑃𝑃(𝑥𝑥) =
𝑑𝑑𝑑𝑑 𝐹𝐹(𝑥𝑥|𝑥𝑥) 𝐹𝐹(𝑥𝑥|𝑥𝑥)
29
* The corresponding homogeneous differential equation
𝑑𝑑𝑑𝑑
𝑑𝑑𝑑𝑑 𝑑𝑑𝑑𝑑
is − 𝑃𝑃 𝑥𝑥 𝑦𝑦 = 0 so we have = 𝑃𝑃 𝑥𝑥 so
𝑑𝑑𝑑𝑑 𝑦𝑦
𝑥𝑥
ln 𝑦𝑦 = ∫0 𝑃𝑃
𝑣𝑣 𝑑𝑑𝑑𝑑 + 𝑑𝑑 so
𝑥𝑥
𝑦𝑦(𝑥𝑥) = exp ∫0 𝑃𝑃 𝑣𝑣 𝑑𝑑𝑑𝑑 exp(𝑑𝑑).
30
𝑥𝑥 𝑥𝑥 𝑓𝑓(𝑣𝑣|𝑣𝑣)
* Denote 𝑢𝑢 𝑥𝑥 = exp ∫0 𝑃𝑃 𝑣𝑣 𝑑𝑑𝑑𝑑 = exp ∫0 𝐹𝐹(𝑣𝑣|𝑣𝑣) 𝑑𝑑𝑑𝑑
* The solution to the non-homogeneous equation is
1 𝑥𝑥 𝑓𝑓(𝑡𝑡|𝑡𝑡)
* 𝑦𝑦(𝑥𝑥) = ∫0
𝑢𝑢 𝑡𝑡 𝑄𝑄 𝑡𝑡 𝑑𝑑𝑡𝑡 with 𝑄𝑄 𝑡𝑡 = 𝑣𝑣 𝑡𝑡, 𝑡𝑡
𝑢𝑢(𝑥𝑥) 𝐹𝐹(𝑡𝑡|𝑡𝑡)
∗ 𝑠𝑠𝑖𝑖 𝑓𝑓(𝑣𝑣|𝑣𝑣) 𝑠𝑠𝑖𝑖
* So 𝑏𝑏 𝑠𝑠𝑖𝑖 = exp − ∫0 𝑑𝑑𝑑𝑑 ∫0 𝑢𝑢 𝑡𝑡 𝑄𝑄 𝑡𝑡 𝑑𝑑𝑑𝑑
𝐹𝐹(𝑣𝑣|𝑣𝑣)
31
𝑓𝑓(𝑣𝑣|𝑣𝑣)
* This can be simplified by noticing that = 𝑙𝑙𝑙𝑙𝑙(𝐹𝐹 𝑣𝑣 𝑣𝑣 )
𝐹𝐹(𝑣𝑣|𝑣𝑣)
∗ 1 𝑠𝑠𝑖𝑖
* So we have 𝑏𝑏 𝑠𝑠𝑖𝑖 = ∫0 𝑣𝑣(𝑡𝑡, 𝑡𝑡)𝑓𝑓(𝑡𝑡|𝑡𝑡)𝑑𝑑𝑑𝑑
𝐹𝐹 𝑠𝑠𝑖𝑖 𝑠𝑠𝑖𝑖
𝑁𝑁+2 𝑡𝑡 𝑁𝑁−1 𝑡𝑡 𝑁𝑁−2
* With 𝑣𝑣 𝑡𝑡, 𝑡𝑡 = and 𝑓𝑓(𝑡𝑡|𝑡𝑡) = 𝐹𝐹′(𝑡𝑡|𝑡𝑡) =
2 𝑣𝑣 𝑣𝑣
𝑁𝑁+2 𝑁𝑁−1
* We therefore obtain 𝑏𝑏 ∗ 𝑠𝑠𝑖𝑖 = 𝑠𝑠𝑖𝑖 .
2 𝑁𝑁
* This is the𝑁𝑁−1
same as in a second price auction, but slightly lower
by a factor to take into account that I pay my own bid.
𝑁𝑁
32
LECTURE 8: BACKWARD INDUCTION Alexia Gaudeul
1
DOMINANCE
* A strategy is dominant if it is the best choice whatever the other
player’s strategy is.
* Most basic concept in game theory.
* Dominance does not depend on what you think the other person
will do.
* Can be applied iteratively (backward induction).
* If another player’s strategy is dominated, he will not play it.
* Therefore I should not play as if he might play it.
* A game is dominance solvable if it has a unique equilibrium
obtained by iteratively deleting dominated strategies.
2
THE PRISONER’S DILEMMA L R
U 75,75 25,90
* U is dominated by D
* L is dominated by R
D 90,25 60,60
* Therefore the unique dominant equilibrium is RD.
* Standard argument against this:
* What is the game is repeated?
* What if players are concerned with efficiency?
* What if LR does not understand that R is dominant? (understanding of own situation) 
plays L
* What if LR understands own situation but does not understand that D is dominant?
(understanding others’ situation)  plays R
* Dominance thus only requires understanding own situation.
3
CENTIPEDE GAME
100
* Rosenthal (1981), with 100 terminal nodes!!!
1 2 3 4 5 298 , 2100
A B A B A
4,1 16, 8, 64,

2,8
4 32 16
* Dubbed by Binmore as the “centipede game”.

* Can be very expensive!
2100 = 1,267,650,600,228,229,401,496,703,205,376 = 1,268
octillions. 4
CENTIPEDE GAME
* The paradox is that even though both players could
makes octillions of euros, backward induction forces them to
make do with a total of 5 euros.
* In practice however, a player will “Take” (stop the game)
only at the point at which he thinks the other player will
“Take” next round.
* This depends on how many steps of backward induction
they think other players can manage.
* E.g. go on until end if level 0. Take just before end if
level 1. Take at step 100 − 𝑡𝑡 if level 𝑡𝑡.
5
CENTIPEDE GAME
* McKelvey, R. D., & Palfrey, T. R. (1992). An
Experimental Study of the Centipede Game.
Econometrica, 60(4), 803–836.
https://doi.org/10.2307/2951567
1 2 3 4 64,
16
A B A B
4,1 16, 8,
2,8
4 32
6
1 2 3 4 64,
16
A B A B
CENTIPEDE GAME 4,1 2,8
16, 8,
4 32
* Portion of game stopping before of at step 𝑋𝑋 (step 5 is the end point). Comparison of rounds 1-5
and round 6-10.
* We see that 8% of subjects pass in the last stage of early rounds of four move game  altruism
of level 0?
* 9 subjects out of a total of 138 subjects chose pass all the time.
7
1 2 3 4 64,
16
A B A B
CENTIPEDE GAME 4,1 2,8
16, 8,
4 32
* Implied probabilities to take at each stage.
8
CENTIPEDE GAME
* Interpretation as game of imperfect information where
the type of the other player is unknown.
* A priori initial probability 𝑟𝑟1 that other player is altruist
and will pass on the last move.
* Players update their probability that the other player is
an altruist over the game and play mixed strategies over
pass and take.
* There is a passing stage (steps < 𝑘𝑘1 ), a mixing stage
(steps in between) and a taking stage (steps > 𝑘𝑘2 ).
9
A GAME OF PAYING IT BACKWARD
Rosenfeld A. (2008): "Pay It Backwards: An Act Of Coffee Kindness",
The Huffington Post, December 23, 2008.
https://www.huffingtonpost.com/arthur-rosenfeld/pay-it-backwards-
an-act-o_b_151793.html
Give Give Give
1 2 3 -1,0,
0,1
Stop Stop Stop
0,0, -1,1, -1,0,

0,0 0,0 1,0
10
BEAUTY CONTEST
* Game first analyzed by Hervé Moulin (1986),
see.
* Nagel, R., Bühren, C., & Frank, B. (2017). Inspired and
inspiring: Hervé Moulin and the discovery of the beauty
contest game. Mathematical Social Sciences, 90, 191–
207.
https://doi.org/10.1016/j.mathsocsci.2016.09.001
11
LEVELS OF REASONING
* Different levels of reasoning in the beauty contest
game:
* Level 0 is choosing a number at random.
* Level 1 is choosing 2/3 of the average of random
numbers  33
* Level 2 is choosing 2/3 of level 1
* Level 3 is …
* In order to win the game, you have to be one step
ahead of others, but not more!
12
BEAUTY CONTEST
* Bids that people make in such a game allow us to
compute how many steps of iterated reasoning people
do, or more precisely, how many they expect others to
do.
* At least, can rank people by their expectations of other
people’s rationality.
* Better than centipede game in one respect, which is
that you cannot expect some portion of other
participants to be altruist.
13
BEAUTY CONTEST
* Fehr, D., & Huck, S. (2016). Who knows it is a game?
On strategic awareness and cognitive ability.
Experimental Economics, 19(4), 713–726.
https://doi.org/10.1007/s10683-015-9461-0
* Use cognitive reflection test to estimate ability to reflect
rather than respond intuitively to problem questions
(Frederick, S. (2005). Cognitive reflection and decision
making. Journal of Economic Perspectives, 19(4), 25–42).
14
BEAUTY CONTEST
* Find that guesses in the BCG
are related to cognitive ability
measured this way.
* But “The CRT measures
subjects’ ability to reflect on a
problem and to suppress
intuitive responses as well as
mathematical skills. This is only
one particular aspect of
cognitive ability”.
* However CRT correlates well
with “Wonderlic Personnel Test
(WPT)”
15
BEAUTY CONTEST
* Only the best performers in the CRT make guesses that are
sensitive to their beliefs about how others did in the CRT.
* I.e. if believe others did well, make lower guesses than if believe
others did badly.
* For other people, no such relation.
* Note: All those results are still under debate, some other studies
do not find a relation, and there are also issues about the level of
motivation of subjects.
* i.e. everybody can probably think strategically, but some just do not
bother (maybe…).
16
L R
GAMES WITH TWO STEPS OF U 9,3 9,3
ITERATED DOMINANCE D 3,4 10,5
* Prisoner’s dilemma only requires understanding one’s own situation.
* Other games require understanding also other person’s situation, how
rational they are, and whether they maximize.
 Study by Beard, T. R., & Beil, R. O. (1994). Do people rely on the self-
interested maximization of others? An experimental test. Management
Science, 40(2), 252-262.
* Look at game above: UD plays first, then LR observes what UD did
and chooses either L or R.
* L is dominated by R when UD plays D, so UD should believe LR will
play R if she plays D, and therefore play D. DR is thus the subgame
perfect equilibrium of the game, obtained by iterated dominance.
17
L R
* Suppose however that UD is not sure that LR is
rational. Assume she believes LR is rational with
probability 𝑝𝑝, and goes against its own interest with
probability 1 − 𝑝𝑝
* UD has the choice between U and getting 9 for sure
or D and R with probability 𝑝𝑝.
* UD should thus play D only if 3 1 − 𝑝𝑝 + 10𝑝𝑝 ≥ 9
* I.e.6if trusts LR to be rational with probability
𝑝𝑝 ≥ = 85%.
7
18
L R
* Variations
L R L R
U 9.75,3 9.75,3 U 9.75,3 9.75,3
D 3,4 10,5 D 3,4.75 10,5
6.75 6.75
* Need 𝑝𝑝 > = 96% Needs 𝑝𝑝 > 7
= 96%,
7 but also requires more trust
about sensitivity of LR to
payoff differences. 19
L R
* In this game, Beard and Beil (1994) find that 66% of UD play U, and
83% of LR play R when UD plays D.
* Given this, it is rational for UD to play U, since too few LR are
sufficiently rational to play R after D.
* Decreasing payoff of U for UD to 7 decreases play of U to 20% and
strangely also increases play of R after D to 100%.
* Decreasing payoff of LD for LR to 3 also decreases play of U to 47%
and increases play of R after D to 100%.
* Increasing payoff of UL and UR to 6 for LR increases play of U to 86%
(fear of retaliation if play D?), even though LR keeps playing R after D is
played (i.e there is no retaliation, but note: few observations…).
20
LECTURE 9: COORDINATION Alexia Gaudeul
1
L R
EQUILIBRIUM SELECTION U 1,1 0,0
D 0,0 1,1
* In many games, there are many equilibria.
* For example, in the coordination game above,
will people coordinate on UL, RD or the mixed
strategy equilibrium?
* In practice, people rely on precedents, focal
points, experience, norms.
* Although different people have different experiences.
2
MISCOORDINATION
* Miscoordination can be solved through communication,
but communication is not always feasible.
* E.g. on the road, you cannot negotiate with every
driver what side of the road to use.
* You may also not anticipate consequences of a
decision, e.g. units of measure, often different across
countries, developed independently until problems of
junction arose (rail tracks are an example).
3
HOW DO PEOPLE COORDINATE
* Schelling's (1960) theory of focal points: ”each person’s expectation of
what the other expects him to expect to be expected to do”.
* Or as per Mehta et al (1994): „when someone is playing a pure
coordination game, she will look for a rule of selection which, if followed
by both players, would tend to produce successful coordination.”
* E.g. „Tomorrow you have to meet a stranger in NYC. Where and when
do you meet them?”
* E.g. three blue squares and one red square. Which one do you choose,
knowing that you get 1€ if you both choose the same square?
4
* Mehta, J., Starmer, C., & Sugden, R. (1994). The Nature
of Salience: An Experimental Investigation of Pure
Coordination Games. The American Economic Review, 84(3),
658–673.
* Designed to discriminate between (i) primary salience and (ii)
secondary and Schelling salience.
* Primary salience: „Each player chooses the strategy whose label
has primary salience for her. Among people with common
experiences and cultural backgrounds, some correlation between
what has primary salience for one person and what has primary
salience for another.”
5
* Secondary salience: „each player chooses the
strategy whose label she believes most likely to have
primary salience for her opponent”.
* Can be generalized to any order of salience, e.g.
people might choose numbers in the Beauty contest
based on primary salience, some people will take
account of this (secondary salience), some will take
account that others will take account of this (third, fourth,
…).
6
* Schelling salience: “rule of selection which, if
followed by both players, would tend to produce
successful coordination.”
* “A rule of selection (and by extension, the label or strategy that it
identifies) is salient to the extent that it "suggests itself' or seems obvious
or natural to people who are looking for ways of solving coordination
problems”.
7
QUESTIONS
1. Write down any year, past, present, or future.
2. Name any flower.
3. Name any car manufacturer.
4. Write down any day of the year: (day) /(month)
5. Name any British town or city.
6. Write down any positive number.
7. Write down any color.
8. Write down any boy's name.
9. Complete the sentence: A coin was tossed. It came down …
10. Complete the sentence: The doctor asked for the patient's records. The nurse gave
them to …
8
QUESTIONS
Assign each circle to
one or other of the
squares.
The way to do this
assignment is as
follows. You must
mark each of the
circles with EITHER
the "hatched" pattern
OR the "spotted"
pattern.
Note: Numbers not shown to subjects
Rule of closeness? Equal sharing?
9
QUESTIONS
For each of these questions we
have drawn a large circle with
six "spokes“, that is, straight or
wavy lines radiating from the
centre.
You must divide the circle up by
drawing thickly over two of these
spokes.
Note: Numbers not shown to subjects
Odd one out?
10
PRIMARY VS. SECONDARY SALIENCE
* Group P: Pick an answer.
* Group C: Pick an answer. You are matched with
someone else and will be paid for every answer in
common with that person.
11
ANSWERS
12
RESULTS
* Clear confirmation of secondary salience  the
modal choice by group P is much more likely to be
chosen by group C.
* Some confirmation of Schelling salience  if there
was no clear modal choice by group P, people were still
very likely to coordinate, sometime not as per
frequency of choice by group P.
* E.g. choice of number 1, answer to question 8, answer to
question 11, answers to questions 17 to 20.
13
THEORY
* Sugden, R. (1995). A Theory of Focal
Points. The Economic Journal, 105(430), 533–
550. https://doi.org/10.2307/2235016
* In matching games, payoff of playing
strategy 𝑠𝑠𝑖𝑖 when other player plays strategy
𝑠𝑠𝑗𝑗 is ∑𝑔𝑔 𝑠𝑠𝑖𝑖𝑖𝑖 𝑠𝑠𝑗𝑗𝑗𝑗 , with 𝑠𝑠𝑖𝑖𝑖𝑖 the proba by 𝑖𝑖 to
play strategy 𝑔𝑔.
14
THEORY
* If the strategies have no label (e.g. pick a ball out
of 5 in an urn, win if ball’s number (from 1 to 5) is
same as that drawn by other, you cannot see the
numbers), then the best strategy is to choose2 at
1 1
random. This maximizes payoff  5 × =
5 5
* If the strategies have a label g, and a label is
less frequent than others, then choose it.
* Why? Suppose three balls are blue and two are red.
Then choose one of the red balls at random. Expected
payoff is then ½.
15
THEORY
* Bacharach and Bernasconi (1997)
* Focality principles include rarity/distinctiveness,
except if the rarity is subtle, and might be picked on
only by some, in which case people might prefer to
choose a less “odd” choice, if few options have that
oddity.
* E.g. One unique feature
1
picked on with probability 𝑝𝑝 will
be chosen only if 𝑝𝑝 > with 𝑛𝑛 the number of options with
𝑛𝑛
the next more frequent but easy to pick oddity.
16
L R
THEORY U 2,2 0,1
D 1,0 1,1
* How do people deal with conflicting principles of
equilibrium selection?
* E.g. stag-hunt game (from Rousseau).
* UL is Pareto-dominant, RD is secure (maximin).
* People have a strong tendency to coordinate on the
less efficient equilibrium (Cooper et al, 1990).
* Which is why hunts / parties need strong and
dynamic organizers…
17
THEORY
* In games requiring assigning objects to different
classes (e.g. A or B), people follow principles of
* Closeness—Assign an object to whichever of A or B is
closer;
* Equality—assign half to A and half to B; and
* Accession—if a subset of objects are closely related to
one another, the subset should not be broken up.
* See assignment in questions 11 to 16 of Mehta et al.
18
THE WEAKNESS OF FOCAL POINTS
* Focal points are very
fragile, small changes in
payoffs destroy them.
* E.g. X= Sears Tower
(Chicago main skyscraper),
Y=AT&T building
* Coordination successful
only if symmetric case.
Crawford, V. P., Gneezy, U., & Rottenstreich, Y. (2008). The Power of Focal Points Is Limited: Even Minute Payoff
Asymmetry May Yield Large Coordination Failures. The American Economic Review, 98(4), 1443–1458.
19
L R
THE ROLE OF COMMUNICATION U 3,2 0,0
D 0,0 2,3
* Tested in the battles of the sexes, with conflicting
preferred coordination.
* If no communication, then do not manage to
coordinate more than in mixed strategy equilibrium.
* If one sided communication, then the one who can
speak announces he will play his favored strategy and
the other person goes along.
* If two sided communication, then back to mixed
strategy equilibrium.
20
THE ROLE OF COMMUNICATION
* Van Huyck, Gillette, and Battalio
(1992).
* People go along with
recommended play, up to some
extent.
* Less so if recommended strategy is
not Pareto-efficient.
* Less so if recommendation is
unequal, except if favors oneself 
21
CONCLUSION
* There are (too) many selection principles for focal
points.
* Theory not yet simple and general enough.
* Difficult to understand how people deal with conflicting
rules of selection of a focal point.
* Difficult to understand how focal points evolved over time.
* Communication does not necessarily improve matters.
* Focal points are rather fragile, they are only a
secondary selection criterion.
22
LECTURE 10: LEARNING Alexia Gaudeul
1
LEARNING HOW TO PLAY A GAME
* How do people learn how to play a game?
* In situations with full information, where you know your
payoffs and the payoffs of others.
* In situations with limited information, up to the limit
where you know only what action you took and what
payoff you got?
2
LEARNING ABOUT NATURE
* Before studying how people learn successful strategies, we first study how
people learn more basic things about the state of nature.
* In particular, we want to know how people learn about the probability of
events, when this probability is determined by nature rather than by the action
of a human.
* Indeed, in games, it is essential to form correct beliefs about the probability
that the opponent will play this or that action.
* This is especially difficult since this probability may change over time.
* Therefore, we first consider if people can learn in a case with probabilities
fixed by nature.
* We show that people do not learn as well as they could; they suffer from
biases.
3
BAYES RULE
4
LEARNING ABOUT THE STATE OF NATURE
* There are two boxes, one with 2/3 red (Box A), the other with 2/3 blue (Box B).
* You draw one ball from one of the two boxes, but you do not know which one is Box A or
Box B.
* This situation represents for example a case where your opponent plays mixed strategies
in a game with two possible actions (red or blue), but you are not sure with what probability
he plays red of blue (i.e. whether he draws from Box A or Box B).
Box A Box B
5
* Suppose you draw Red. What is the probability
the box is Box A?
1
* ?
2
1
* ?
3
2
* ?
3
6
* Bayes’ rule:
Pr 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵&𝑅𝑅𝑅𝑅𝑅𝑅 Pr 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵&𝑅𝑅𝑅𝑅𝑅𝑅
Pr 𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 𝑅𝑅𝑅𝑅𝑅𝑅 = =
Pr 𝑅𝑅𝑅𝑅𝑅𝑅 Pr 𝑅𝑅𝑅𝑅𝑅𝑅&𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 + Pr 𝑅𝑅𝑅𝑅𝑅𝑅&𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵
2 1
Pr 𝑅𝑅𝑅𝑅𝑅𝑅|𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 Pr(𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵) ( ) 2
= = 3 2 =
2 1 1 1
Pr 𝑅𝑅𝑅𝑅𝑅𝑅|𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 Pr(𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵) + Pr 𝑅𝑅𝑅𝑅𝑅𝑅|𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 Pr(𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵) ( )+ ( ) 3
3 2 3 2
7
BAYES RULE IN PRACTICE
* People seem to follow Bayes’ rule quite well for events that are not too rare
or not too frequent.
* The issue occurs for rare and frequent events: They underweight frequent
events and overweight rare events.
* Example: You got a positive results from a test for a rare disease, which
affects 1/1000 people on average.
* “Positive” means that you have the disease :\
* However the test for the disease misdiagnoses in 1% of the case if you do
not have the disease (false positive rate =1%)
* If you have the disease, it catches it 100% of the time (false negative
rate=0%).
* What is the probability that you have the disease?
8
BAYES RULE IN PRACTICE
* If you make the calculations, you find that the probability you do have the disease is “only” 1/11.
Pr 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷&𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
Pr 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 =
Pr 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
Pr 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷&𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
=
Pr 𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷&𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 + Pr 𝑁𝑁𝑁𝑁𝑁𝑁𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷&𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃
Pr 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃|𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 Pr(𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷)
=
Pr 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃|𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 Pr(𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷) + Pr 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃|𝑁𝑁𝑁𝑁𝑁𝑁𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷 Pr(𝑁𝑁𝑁𝑁𝑁𝑁𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷𝐷)
1
1( ) 1 1
= 1000 = ≅
1 1 999 999 11
1( )+ ( ) 1+
1000 100 1000 100
9
COUNTING RULE
* Suppose there are 1000 people.
* 1 of them has the disease.
* Test would catch this person (true positive=100%)
* 999 do not have the disease.
* Test would test 999/100 as having the disease (false positive=1%).
* Therefore 1+999/100 will be tested “positive”.
* Of those, only 1 has the disease.
* So the probability to have the disease if the test turns positive is
1/(1+9.99)
10
BASE RATE BIAS
* People tend to underweight prior information
* E.g. the fact that the rare disease occurs only with
probability 1/1000.
* Suppose for example they ignore this information
and assume probability is ½.
11
BASE RATE BIAS
* Then ex-post they believe proba to have the disease is
1
1( ) 1
2
1 1 1 = 1 ≅1
1( )+ ( ) 1+
2 100 2 100
* Which corresponds to the reaction of some people when they get test
results!
* In Kahneman and Tversky (1973) “On the psychology of
prediction”, such things seem to happen when people are told,
e.g., prior info that in a sample 70% are lawyers and 30% are
engineers, and are given neutral description of a person in that
sample, they assign that person to be a lawyer with proba 50%.
12
REPRESENTATIVENESS HEURISTIC
* Kahneman, D., & Tversky, A. (1973). On the psychology of prediction.
Psychological Review, 80(4), 237–251.
https://doi.org/10.1037/h0034747
* “people predict by representativeness, that is, they select or order
outcomes by the degree to which the outcomes represent the essential
features of the evidence”
* Experiment
* Some people are asked to estimate proportion of students in each field,
* Some others are given a description of a person and asked how similar he is
to typical student in that field,
* Finally, some asked likelihood that person is student in a field.
13
* “Tom W. is of high intelligence,
although lacking in true creativity. He has
a need for order and clarity, and for
neat and tidy systems in which every
detail finds its appropriate place. His
writing is rather dull and mechanical,
occasionally enlivened by somewhat
corny puns and by flashes of imagination
of the sci-fi type. He has a strong drive
for competence. He seems to have little
feel and little sympathy for other people
and does not enjoy interacting with
others. Self-centered, he nonetheless has
a deep moral sense.”
14
* This means that an event will be ascribed to the condition that most
look like it, without due regard for the probability of that condition.
* E.g. a person drawing 2 red ball and one blue would say the box is A with
higher likelihood than reasonable.
* Other example:
* Linda is 31 years old, single, outspoken, and very bright. She majored in
philosophy. As a student, she was deeply concerned with issues of discrimination
and social justice, and also participated in anti-nuclear demonstrations. Which is
more probable?
* (a) Linda is a bank teller.
* (b) Linda is a bank teller and is active in the feminist movement.
15
IMITATION
16
IMITATION
* On the same principle as we started learning about
belief updating with a simple case, we start learning with
the simplest form of learning, imitation.
* Imitation is a good strategy if you know nothing and you
believe others do know something about the situation.
* E.g. if you see people running away from a place, it can be a
good idea to run with them.
* However, this can lead to irrational herd behavior, i.e. for some
random reason, someone starts to run, and then others follow.
17
LEARNING ABOUT THE STATE OF NATURE,
RELOADED
* One person draws a ball from a box, not knowing if it is box A or box B.
* Then he announces which box he thinks he drew from. However, he does not announce the
color of his ball.
* Then another person learns what the first person announced, and also draws a ball from
a box, again not knowing which box he is drawing from.
Box A Box B
18
INFORMATION CASCADES
Prior guess Own draw Guess
A Red A
A Blue ? B?
B Red ?A?
B Blue B
People in the second round give more weight to their own information
 guess based on own draw if contradicts first guess.
19
Prior guesses Own draw Guess
A,A Red A
A,A Blue A
A,B Red A
A,B Blue B
In the second round, there is more of a possibility for starting an

information cascade. In the second row, the person may starts ignoring
his own information  start of an information cascade
20
* Anderson, L. R., & Holt, C. A. (1997). Information cascades in the laboratory.
The American Economic Review, 847–862.
http://www.jstor.org/stable/2951328
* Cascades are not an issue if the first two draws led to correct inference.
* However, they can lead to wrong behaviour (reverse cascade) if first two draws were
not representative of their urn.
* For example, two Red balls has probability 4/9 if draw from Box A, probability 1/9
if draw from Box B  Proba 1/5 that two red balls are from Box B.
* Reverse cascades account for about ½ of cascades. People follow a cascade (i.e. start
to ignore own information) in large majority of cases where prior guesses make ignoring
own information optimal
* There is a limit to how much information can be processed by a group. In our case, only
the first few draws are informative, others are merely imitative.
21
THE COUNTING HEURISTIC
* Also test an asymmetric design to see if people rely too much on “counting”, i.e. predict
urn that corresponds to the majority of previous guesses.
* In this example, blue ball is much more informative than red ball  people should
reverse cascade more often when see blue ball.
* However, this is not the case. People tend to following a counting heuristic.
Box A Box B
22
APPLICATIONS
* Bikhchandani, S., Hirshleifer, D., & Welch, I. (1992). A Theory of Fads,
Fashion, Custom, and Cultural Change as Informational Cascades. Journal of
Political Economy, 100(5), 992–1026. http://www.jstor.org/stable/2138632
* “Four primary mechanisms have been suggested for uniform social behavior:'
(1) sanctions on deviants, (2) positive payoff externalities, (3) conformity
preference, and (4) communication.”
* They propose information cascades as a complementary alternative that can
explain also why cascades may break down, and the fragility of norms, fashions
and fads.
* Applications to politics (early voting states exert influence on later voting
states in primaries in the US), medical practice (some operations come in and out
of fashion, such as tonsillectomy), finance (takeover targets frequently attract
competing bidders), peer pressure and stigmatisation.
23
APPLICATIONS
* (Thankfully,) some forces go against conformity.
* For example: Why do so many men grow a beard
when others do, and what drives some to go the other
way after a while?
* Negative frequency-dependent selection: The more
frequent a trait, the less attractive it becomes.
* Also important topic for epidemics, e.g. a flu strain that is
too successful one year will not be successful next year
(previous victims now either dead or resistant)  an illness
that is too successful does not survive very long.
24
RECAPITULATION
* We saw how people learn about probabilities,
and we studied a basic learning strategy via
imitation.
* People have some issues with Bayesian updating
for extreme probabilities, and imitation can only
manage a limited amount of learning.
25
LEARNING SUCCESSFUL STRATEGIES
26
* We now apply theories of learning to strategic
games, i.e. when you are trying to do the best given
someone else also trying to do the same.
* You then want to learn what the best strategy is, which
does not, BTW, necessarily require you learn how the other
person is playing.
* Different from previous examples where learning was
about Nature (how many balls of a given color in an urn).
27
* How do people learn how to play games?
* Several theories:
* Evolutionary learning  strategies that increase
fitness survive. Works at the level of a specie.
* Reinforcement learning  strategies that worked
well in the past are more likely to be played.
28
* Belief learning  strategies that would work well given
one’s belief about what strategies others adopt will be
played.
* At one extreme, believes other will play same as last period  best
response dynamics.
* At the other extreme, choose strategy that performs best against average
behavior of opponent in the past.
* Experience-weighted attraction learning: Mix of the two
learning above.
* Compared to reinforcement learning, adds consideration of how unchosen
strategies would have performed in the past.
29
* Anticipatory learning: Considers what other player
would do given one’s own behavior in the past.
* Requires good knowledge of other’s payoffs and possible
actions, and of how she herself learns.
* Imitation, that is, adopting strategies of others.
* Imitating the best of the others in the past.
* Imitating the person “closest” to you.
* …
30
* Learning direction theory: People change
strategies “in the direction of” the better
performing strategies.
* Rule learning: People do not learn strategies,
they learn rules of behavior.
* Optimal strategies may be too difficult to find, so
people simplify the situation and adopt heuristics.
31
EVOLUTIONARY LEARNING
32
TIT-FOR-TAT IN THE PRISONER’S DILEMMA
* Evolutionarily stable strategy (ESS) = A strategy which is robust against a
tiny invasion of mutants.
* “Learning” is performed through random trials; there are random mutations leading to
changes in the strategies being played.
* A strategy that performs well against the mix of existing strategies grows, others
decline.
* Maynard Smith, J., & Price, G. R. (1973). The Logic of Animal Conflict. Nature,
246(5427), 15–18. https://doi.org/10.1038/246015a0
* Looks at reason why animals fight little within own specie.
* C = fight as per convention (for show)
* D = fight dangerously (risk of injury)
* R = retreat
33
* Compare different strategies, like “mouse” (C if C, R
in response to D), “hawk” (D all the time), “bully” (D if C,
C if D, R if DD), “retaliator” (C if C, D if D, R after a
while), “prober-retaliator” (sometimes initiates D and
keep at it if no retaliation).
* Only Retaliator is an ESS, prober-retaliator is almost
an ESS, Mouse performs well only if many retaliators,
i.e. free-riding strategy, not robust on its own.
34
* Applied to social sciences
* Axelrod (1984), The Evolution of Cooperation, Basic
Books.
* Very captivating book, highly recommended.
* Based on the study of the prisoner’s dilemma.
35
* Challenging others to play against a tit-for-tat
program (computer tournaments).
* Tit-for-tat  play C if opponent played C last period. play D if
opponent played D last period.
* Much better than grim-trigger in that this strategy is forgiving.
* Proposed by Rapoport, mathematical psychologist with interest in
peace research.
* No other program one manages to do better in terms of average
payoff.
* So this strategy is an ESS.
36
* Rules that performed best were “nice”, i.e. started with C and
never chose D unless provoked.
* Worst nice rule was the “grim trigger”, i.e. never cooperate again
with someone who once did D.
* Rules also had to do well with nasty rules, such as DOWNING,
which tests the responsiveness of opponent to changes in strategy,
and then exploits it.
* So the rule must be tough with tough players.
* TFT is based on the concept of reciprocity, but making sure that
the response is measured, to avoid ratcheting, i.e. that any D gets
blown out of all proportion.
37
REINFORCEMENT LEARNING
38
* Does not require any information about payoffs
of others.
* Only requires info about own payoff  good for
low info environment or environments that change.
* Maybe not so realistic for high-info environments.
39
* Erev, I., & Roth, A. E. (1998). Predicting How People Play
Games: Reinforcement Learning in Experimental Games with
Unique, Mixed Strategy Equilibria. The American Economic Review,
88(4), 848–881. http://www.jstor.org/stable/117009
* 100 periods or more of games with a unique equilibrium in nontrivial
mixed strategies (not all equal proba, no proba =1)
* Total of 12 games looked at.
* Testing different theories based on simulations and goodness of fit
with real play.
* Simulations based on parameters in 11 games, test on the 12th game
* Out-of-sample testing, because it is too easy to fit games on a case by case basis.
40
Examples:
41
* There appears not to be a lot of learning except in the
first few rounds on average (in the aggregate)
* However, learning does occur at the individual level (not shown).
* As already known, endpoints of learning can be quite far
from MSE.
* Modeling:
* Initial propensities 𝑞𝑞𝑛𝑛𝑛𝑛 (1) with 𝑛𝑛 the strategy and 𝑘𝑘 the player.
* Reinforcement function 𝑅𝑅(𝑥𝑥) = 𝑥𝑥 − 𝑥𝑥min with 𝑥𝑥 the payoff
and 𝑥𝑥min the minimum payoff in the game.
42
* Updating of propensities
* 𝑞𝑞𝑛𝑛𝑗𝑗 𝑡𝑡 + 1 = 𝑞𝑞𝑛𝑛𝑛𝑛 (𝑡𝑡) + 𝑅𝑅(𝑥𝑥) if 𝑗𝑗 = 𝑘𝑘
* 𝑞𝑞𝑛𝑛𝑗𝑗 (𝑡𝑡 + 1) = 𝑞𝑞𝑛𝑛𝑛𝑛 (𝑡𝑡) otherwise
* Probabilistic choice rule:
𝑞𝑞𝑛𝑛𝑛𝑛 𝑡𝑡+1
* 𝑝𝑝𝑛𝑛𝑛𝑛 𝑡𝑡 + 1 =
∑𝑞𝑞𝑛𝑛𝑛𝑛 𝑡𝑡
∑𝑞𝑞𝑛𝑛𝑛𝑛 1
* Strength of initial propensities 𝑠𝑠𝑛𝑛 1 = with
𝑋𝑋𝑛𝑛
𝑋𝑋𝑛𝑛 the “average” payoff of the player in the game.
43
* Assuming same strength across players  𝑠𝑠(1)
𝑋𝑋𝑛𝑛
* So 𝑞𝑞𝑛𝑛𝑛𝑛 1 = 𝑠𝑠 1 with 𝑀𝑀𝑛𝑛 the total number of strategies.
𝑀𝑀𝑛𝑛
* This determines the speed of learning.
* If 𝑠𝑠(1) is high, then people learn slowly, as 𝑅𝑅(𝑥𝑥) small
compared to 𝑞𝑞𝑛𝑛𝑛𝑛 .
* Test of this model vs. more complicated models with more
flexibility, i.e people keep experimenting with some
probability (i.e. try strategies with some proba independent
of learning) and “forget”, i.e. propensities depreciate.
44
* Findings:
* The one parameter model does better than MSE.
* Adding forgetting and experimentation improves a
bit,
* Adding sophistication with fictitious play (strategy that
would do best vs. past) does not improve things.
45
EXPERIENCE WEIGHTED LEARNING
46
WEIGHTED FICTITIOUS PLAY
* EWL includes a model of learning, whereby people expect people will
play what they did in previous periods, with a parameter 𝜙𝜙 to discount
old observations.
𝑗𝑗 𝑗𝑗
* Beliefs (Expectations) are 𝐸𝐸 𝑠𝑠−𝑖𝑖 𝑡𝑡 = (1 − 𝜙𝜙)𝐼𝐼 𝑠𝑠−𝑖𝑖 (𝑡𝑡) +
𝑗𝑗
𝜙𝜙𝐸𝐸 𝑠𝑠−𝑖𝑖 𝑡𝑡 − 1
* If 𝜙𝜙 is 0, then you expect the person to do the same as last period.
𝑡𝑡−1
* 𝜙𝜙 declining with time, e.g. 𝜙𝜙 = accumulates information without
𝑡𝑡
discounting.
* Under weighted fictitious play, people choose the strategy that
performs best given their belief.
47
EXPERIENCE WEIGHTED LEARNING
* In experience weighted learning, you discount both
observations that are old, and good experiences with
given strategies if those experiences are old.
* Choice of strategy is based on a mix of what worked
well in the past and what would work best given past
observations.
* Allows people to adapt more quickly by considering
counter-factuals: what I would have gotten if I had played
something else than what I did.
48
RULE LEARNING
49
RULE LEARNING
* Generalization of previous rules, whereby people consider
what would have worked best: imitation, best response,
experience, Nash, …
* Issue that many of the model make very similar predictions.
* Can be solved only partially by designing games where predictions
made by different rules are as different as possible.
* Issue also with over-fitting: the more complex models “
perform” best  you must take into account the number of
parameters in each model and favor the ones that are “frugal”.
* BIC: Bayesian Information Criterion = function of the goodness of fit
(log-likelihood) and of the number of parameters.
50

Behavioral Game Theory

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Behavioral Game Theory

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Alexia Gaudeul

MA BEHAVIORAL GAME THEORY Georg-August-Universität

ESSAY (15 PAGES)

QRE graph when 𝜆𝜆 = 1

As 𝜆𝜆 increases, the equilibrium converges to (D,R).

* Otherwise, get payoff

(Adapted from lecture slides by Alec Sproten & Lilia Zhurakhovska)

* Happenstance data are a by-product of uncontrolled

* Application 1: Testing Theory

* Application 2: Establish empirical regularities

* Application 3: Comparing institutions

* Application 4: Wind Tunnel Experiments

* Before designing an experiment, you must have

* After having formulated a research question, you

* How much realism should I impose on my

* You do not want to replicate the complexity of field

* You do not also want to replicate an economic model

* Also, models are not a good guide for

* Create simplest possible economic environment

* Experiments are designed to test hypotheses.

* Implementing one change only between

* A is choosing the fraction 𝑓𝑓

* What can be treatment variables?

* In within-subject design, always control for order-

* Make sure that treatments are assigned randomly!

* Who will be your participants?  more on this later

* Write instructions for each treatment

* Run pilot experiment

* Paper and Pencil vs. Computerized

* Advantages of paper and pencil experiments

* Advantages of computerized experiments

* Advantages of online experiments

* Advantages of laboratory experiments

* Advantages of classroom experiments

* Do not reveal your own experimental goals

* Complete description of the rules of the game

* In complicated experiments it may make sense that

* Instructions are never 100% complete and clear

* How to present instructions?

* What if subjects do not understand something?

* Payments should vary with subjects‘ actions

* Incentives are generally monetary

* Students vs. Professionals

* Most participants are undergraduate or graduate

* Grad students can be bad subjects:

* Some demographic variables could directly

* Differences in populations can therefore matter,

* Example of questionnaire on demographics:

* You may want to control for subjects’ individual

* Risk from the German Socio-Economic Panel GSOEP

* Positive reciprocity questions from GSOEP (Dohmen, Falk, Huffman

* When writing your instructions, you should be mindful of

* Example: Public Goods experiments with punishment

* Example : Tversky and Kahneman, 1986

* In this case, the frame

* Burnham, McCabe, Smith 2(000), vary the word of

* Generally, the experimenter would prefer a

* Another issue to be mindful of when writing

* Example : Tversky and Kahneman (1974)

* Typically in the experimental instructions it is written:

* One-Shot (without repetition)

* Partner (groups of subjects stay together for several

* A major advantage of experimental data is that

* At the same time, experimental datasets have