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Lecture 1
Francesco Squintani
Email: f.squintani@warwick.ac.uk
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Syllabus
1. Games in Strategic Form
Definition and Solution Concepts
Applications
Readings: Chapter 2, 3, 12
2. Mixed Strategies
Nash Equilibrium and Rationalizability
Correlated Equilibrium
Readings: Chapter 4
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3. Bayesian Games
Definition
Information and Bayesian Games
Cournot Duopoly and Public Good Provision
Readings: Sections 9.1 to 9.6
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5. Extensive-Form Games
Definition
Subgame Perfection and Backward Induction
Applications
Readings: Chapters 5, 6 and 7
8. Bargaining
Ultimatum Game and Hold Up Problem
Rubinstein Alternating Offer Bargaining
Nash Axiomatic Bargaining
Readings: Section 6.2 and Chapter 16
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9. Review Session
Solution of Past Exam Questions
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Structure of the Lecture
Definition of Games in Strategic Form.
Solution Concepts
Nash Equilibrium, Dominance and Rationalizability.
Applications
Cournot Oligopoly, Bertrand Duopoly, Downsian
Electoral Competition, Vickrey Second Price Auction.
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What is Game Theory?
Game Theory is the formal study of strategic
interactions.
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Games in Strategic Form
A game in strategic form is
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Solution Concepts
A solution concept is a mathematical rule to find the
solution of a game.
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Nash Equilibrium
A (pure-strategy) Nash equilibrium is a strategy profile
s with the property that no player i can do better by
choosing a strategy different from si, given that every
other player j adheres to sj.
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There are two main justifications for Nash Equilibrium:
Self-Enforcing Contract.
The players meet and agree before playing on the
course of actions s. The contract s is self-enforcing if
no player has reasons to deviate if the others do not.
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Dominance
A players strategy strictly dominates another one if it
gives a higher payoff, no matter of what other players do.
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Player 2
Player 1 C D
A 1, 1 0, 0
B 0, 0 0, 0
There are two Nash Equilibria: (A,C) and (B,D).
The Nash Equilibrium (B,D) is weakly dominated.
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Rationalizability
Rationalizability is defined via iterated deletion of strictly
dominated strategies.
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For each t = 0, . . . , T 1, Xit+1 is a subset of Xit such
that every strategy of player i in Xit that is not in Xit+1 is
strictly dominated in the game where the set of strategy
of each player j is reduced to Xjt
(in each round, delete all strictly dominated strategies).
Each player knows that every player knows that every player
is rational: She deletes all strictly dominated strategies in the
reduced game.
Quiet Fink
Suspect 1
Quiet 2, 2 0, 3
Fink
3, 0 1, 1
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Solutions of Prisoners Dilemma
Quiet Fink
Quiet 2, 2 0, 3
Fink 3, 0 1, 1
Fink is the best response of each player, regardless of what
the other player does. Fink is the strictly dominant and
rationalizable strategy. (Fink, Fink) is the Nash Equilibrium.
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Bach or Stravinsky
Two daters would rather be together than separate, but
dater 1 prefers Bach and dater 2 prefers Stravinsky.
Bach 2, 1 0, 0
Stravinsky 0, 0 1, 2
If they can coordinate, either the two daters go to Bachs
concert or to Stravinskys concert.
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Solutions of Bach or Stravinsky
Bach Stravinsky
Bach
2, 1 0, 0
Stravinsky 0, 0 1, 2
For each player, B is the best response to B, and S is the best
response to S. There are two Nash Equilibria, (B, B) and (S, S).
All strategies are rationalizable, and none is dominated.
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Matching Pennies
Player 1 wins if the coins are matched.
Player 2 wins if they are not matched.
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Player 2
Head -1, 1 1, -1
Tail 1, -1 -1, 1
There is no sure way to win for either of the players.
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Solutions of Matching Pennies
Head Tail
Head
-1, 1 1, -1
Tail
1, -1 -1, 1
For player 1, H is the best response to T and viceversa, for
player 2, H is the best response to H and T is the best
response to T. All strategies are rationalizable and none is
dominated. There are no Nash Equilibria. 28
Cournot Oligopoly
A good is produced by n firms.
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Linear Costs and Demand
Firm is revenue is qi P(q1 + + qn).
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To find the Best Response Functions, differentiate pi
with respect to qi, set it equal to zero, and obtain:
dpi (q1, , qn)/dqi = a qi (q1 + + qn) c = 0.
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Solving the above equation, we find that the Nash
equilibrium quantity is:
qi* = [a c]/(n+1).
[a c]/3 q1
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Bertrand Competition
Unlike Cournot competition, firms compete in prices.
The firm setting the lowest price sells to all the market.
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Linear Costs and Demand
Ci(qi) = cqi, i=1, , n.
pj
c pm pi
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If pj = c, then pi(p) < 0 for pi < pj,
pi(p) = 0 for pi > pj : bi(p) = {pi : pi > pj}.
If pj > pm, then bi(p) = {pm}.
pi pi
pj
c pm pi c pm pj pi
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If c < pj < pm then pi(p) increases in pj, but
discontinuously drops at pi = pj. So, bi(p) = f.
The best response correspondence is empty.
pi
c pj pi
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In sum, the best-response correspondence is:
bi(p) = {pi : pi > pj}, if pj < c,
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Best Response Functions
Fix the policy x2 of candidate 2 and consider 1s choice.
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If x1 > x2, then candidate 1 wins the votes of citizens
with ideology y > ( x1 + x2 ).
She wins more or less than of the votes if and only if
1 F( ( x1 + x2 )) > .
In this case, she wins the election.
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For x2 > m, b1 (x2) = {x1 : 2m - x2 < x1 < x2}.
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Intuitively, consider any pair of platforms (x1, x2) other
than (m, m). One candidate can win the election by
deviating and locating e closer to m than x2.
Hence (x1, x2) is not a Nash Equilibrium.
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Vickrey Second-Price Auctions
In an English auction, n bidders submit increasing
bids for a good, until only one is left, who wins the
auction.
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The English auction is equivalent to a sealed-bid
auction, in which each bidder decides, before bidding
begins, the most she is willing to bid.
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Second-Price Auction Game
Players: n bidders. Bidder is valuation is vi, we order
v1> > vn > 0, without loss of generality.
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Nash Equilibria
1. (b*1, , b*n) = (v1, , vn).
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2. (b*1, , b*n) = (v1, 0, , 0)
Bidder 1 wins the object, her payoff is v1.
The payoff of bidders i = 2, , n is 0.
If bidding bi > v1, the payoff is vi b1 = vi v1 < 0.
If bidding bi < v1, she loses the object, the payoff is 0.
bi < vi vi - bi 0 0
bi = vi vi - bi vi - bi 0
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vi < bi < bi or bi > bi or
bi < vi bi =bi & i wins bi =bi & i loses
bi = vi vi - bi 0 0
bi > vi vi - bi vi bi (< 0) 0
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Summary of the Lecture
Applications
Cournot Oligopoly, Bertrand Duopoly, Downsian
Electoral Competition, Vickrey Second Price Auction.
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Preview Next Lecture
Mixed Strategies.
Correlated Equilibrium.
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