EC3324 Topics in Game Theory

Francesco Feri
[email protected]
Office hours: in H312 at
11:00 to 12:00 on Tuesday
8:00 to 9:00 on Wednesday
Assessment
2 on-line tests (1 hour each), which contributes 10% of the final
grade (6th and 11th week, 10% each test).
Test 1: on lectures 1, 2, 3
Test 2: on lectures 4, 5, 6, 7
2-hour unseen final exam, which contributes 80% of the final
grade (about all topics).
three unassessed take-home assignments (4th, 9th and 12th week)
 Reading
Robert Gibbons, A Primer in Game Theory, Harvester
Wheatsheaf 1992.
Additional readings could be assigned from time to time. They are an
integral part of the class and you are expected to read them.

2
Structure of the course
Lecture 1, 2, 3
Normal Form Games and Nash Equilibrium, Economic
applications
Lecture 4, 5, 6, 7
Dynamic games of complete information, either with perfect of
imperfect information. Repeated games. Economic applications.
Lecture 8, 9 10
Static and dynamic games of incomplete information. Economic
applications.

3
 Lecture 1

Basic Theory, Normal Form Games and

Iterated dominance
 Game Theory - Motivation

Game Theory is a tool to understand situations in

which two or more decision-makers interact.
Outcomes of (economic) decisions frequently depend
on others actions
effect of price policy depends on competitors
outcome of wage negotiations depends on choices
of both sides
outcome of elections depends on others votes
 Decision makers should thus take expectations of
others decisions into account
Such situations are plausibly modeled as a game,
a model of interactions where the outcome depends
on others as well as ones own actions
this definition and the scope of game theory is much
broader than the everyday definition of a game
e.g., game theory is not only concerned with
winning a competitive game
 Useful Definitions
A fact F is common knowledge if:
Each player know F
Each player knows that the others know F
Each player knows that the every other players knows that
each player know F
And so on

A player is rational if he select the action that leads to the

outcome he most prefers
(or he is maximizing his expected utility)

Beliefs: players assessment about the behaviour of the others

in the game
 Classification of Games
According to the timing
Static games (or simultaneous move game):
Actions are taken simultaneously (i.e. without
information about others moves)
Normal form representation
Dynamic games (or sequential games):
Actions are taken in according a sequence
extensive form representation
 Information, complete versus incomplete:
Complete information: each players payoff function
is common knowledge
Incomplete information: some player is uncertain
about another players payoff function.
Information, perfect versus imperfect
Perfect information: when players have to move, they
know the full history of play of the game
Imperfect information: some player has to move
without knowing the full history of the play of the
game
 Normal form representation
A normal form specifies:
1. the agents in the game,
2. for each agent a set of available actions (or
strategies): Si denotes the set of strategies available
to player i and si is an element of Si
3. The payoff received by each player for each
combination of strategies.
ui (s1 si sn) denotes the payoff function of
player i where (s1 si sn) are the actions
chosen by the players
G = {S1,.. Sn; u1 un }
 Example 1: the Prisoners Dilemma
Static games sometime can be represented using tables

Player 2
Not confess Confess
Player 1 Not confess -1, -1 -9, 0
Confess 0, -9 -6, -6

This game captures many situations where players prefer to

defect, but prefer both to cooperate over both to defect
 Example 2: the Battle of the Sexes
Player 2
Ball Theatre
Player 1 Ball 2,1 0,0
Theatre 0,0 1,2
This game captures many situations where players agree that
they want to coordinate but disagree about the action to
coordinate on.
 Example 3: Matching Pennies
Player 2
Head Tail
Player 1 Head 1,-1 -1,1
Tail -1,1 1,-1

Player 1 wants both to choose the same action, player 2 to

choose different actions.
This is an example of a strictly competitive game,
 Example 4: Stag-Hunt
Player 2
Stag Hare
Player 1 Stag 2,2 0,1
Hare 1,0 1,1

Stag-Hunt models situation where players have a common

interest to cooperate, but may want to play a safe strategy if
they are not sure whether the other will cooperate
 Iterated elimination of strictly
dominated strategies
Example: Prisoner Dilemma
Player 2
Not confess Confess
Player 1 Not confess -1, -1 -9, 0
Confess 0, -9 -6, -6
If player 2 is going to play Not confess, then
player 1 prefer Confess
If player 2 is going to play Confess, then player 1
prefer Confess
Player 1 prefers Confess in both cases
We say that for player 1 playing Not confess is
dominated by playing Confess
 Definition of dominated strategy
si' is strictly dominated by si if:
ui(si, s-i) > ui (si' , s-i)
for each feasible combination of other players strategies (s-i )

Note:
1) rational players do not play strictly dominated strategies
(because a strictly dominated strategy is not optimal for
all possible beliefs)
2) si' is dominated by si if:
ui(si, s-i) ui (si' , s-i)
 Example 1

Player 2
L R
T 2,3 5,0
Player 1 M 3,2 1,1
B 1,0 4,1

Player 2
L R
T 2,3 5,0
Player 1 M 3,2 1,1
 Player 2
L R
T 2,3 5,0
Player 1 M 3,2 1,1

Player 2
L
T 2,3
Player 1 M 3,2

Player 2
L
Player 1 M 3,2
 This process is called iterated elimination of
strictly dominated strategies
(or iterated dominance)
The strategies that survive iterated dominance is
called rationalizable strategies
It is based on the idea that rational players do not
play dominated strategies
Two problems:
This process requires that it is common
knowledge that player are rational
This process often produces no accurate
predictions (see the following example)
 Example 2

Player 2
L C R
T 2,3 2,2 5,0 3
Player 1 Y 3,2 5,3 3,1
Z 4,3 1,1 2,2
B 1,2 0,1 4,4 1

2
Definition of Best Response

The Best Response of a player is his preferred action

given the strategies played by the other players.
Consider the n-player normal form game

= 1, . .  ; 1 
The best response of player i to the strategies s-i =
( 1, ,  ,  , ) solves the following
problem:
max ( 1, , , , )
 
 Nash Equilibrium

It is a prediction about the strategy each player will

choose
This prediction is correct if each players predicted
strategy is a best response to the predicted
strategies of the other players.
Such prediction is strategically stable or self
enforcing: no player wants to change his/her
predicted strategy
We call such a prediction a Nash Equilibrium.
 Definition of Nash Equilibrium
Consider the n-player normal form game
G = {S1,.. Sn; u1 un }
The strategy profile  , ,  is a Nash equilibrium if:
for every player i and every action siSi:
  , ,  , ,    , ,  , , 
The strategy profile  , ,  is a Strict Nash
equilibrium if:
for every player i and every action siSi:
  , ,  , ,  >   , ,  , , 
Note
1. in a Nash equilibrium there are no players that
want to deviate
2.  solves the following problem:
max   , ,  , , 
 

3. in a Nash equilibrium, each player strategy is a

best response to the other players' strategies
 Example 1: the Prisoners Dilemma
Player 2
C(ooperate) D(efect)
Player 1 C(ooperate) 2,2 0,3
D(efect) 3,0 1,1

The unique Nash equilibrium is (D,D)

For every other profile, at least one player wants to deviate
 Example 2: the Battle of the Sexes

Player 2
Ball Theatre
Player 1 Ball 2,1 0,0
Theatre 0,0 1,2
There are two Nash equilibria: (Ball, Ball) and
(Theatre, Theatre)
 Example 3: Matching Pennies
Player 2
Head Tail
Player 1 Head 1,-1 -1,1
Tail -1,1 1,-1
There is no Nash equilibrium (of the game with ordinal
preferences)
 Example 4: Stag-Hunt
Player 2
Stag Hare
Player 1 Stag 2,2 0,1
Hare 1,0 1,1
There are two equilibria:
(Stag, Stag) and (Hare, Hare)