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Introduction To Applied Game Theory

This document provides an introduction to sequential or extensive-form games. It discusses key concepts like backward induction, strategies, subgames, and subgame perfect Nash equilibria. An example predation game is presented and solved using backward induction to find the subgame perfect Nash equilibrium of (In; A), where the entrant chooses to enter and the incumbent chooses to accommodate. The document also discusses how threats can be used to deter entry even if fighting is not a dominant strategy, and how the concept of subgame perfection rules out non-credible threats. Finally, it briefly introduces extensive-form games with incomplete or imperfect information.

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pranjan88
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50 views

Introduction To Applied Game Theory

This document provides an introduction to sequential or extensive-form games. It discusses key concepts like backward induction, strategies, subgames, and subgame perfect Nash equilibria. An example predation game is presented and solved using backward induction to find the subgame perfect Nash equilibrium of (In; A), where the entrant chooses to enter and the incumbent chooses to accommodate. The document also discusses how threats can be used to deter entry even if fighting is not a dominant strategy, and how the concept of subgame perfection rules out non-credible threats. Finally, it briefly introduces extensive-form games with incomplete or imperfect information.

Uploaded by

pranjan88
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PDF, TXT or read online on Scribd
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Introduction to Applied Game

Theory
Lecture 6

Applied Game Theory 1


Sequential/ Extensive-form Games
 There is a clear order of play or there is
possibility of moving first.

 Look forward and reason backward


(Backward induction)

Applied Game Theory 2


Strategies
 Strategy – independent of other’s choices
– specify actions at all possible nodes –
prevent off-equilibrium play
1

A B

2
2
C D
C D

 Nodes; Subgames

Applied Game Theory 3


Strategies
 S1={A, B}

 S2={C if A, C if B;
C if A, D if B;
D if A, C if B;
D if A, D if B}

={CC; CD; DC; DD}

Applied Game Theory 4


Example
 Backward induction solution: (B; DD)
 Backward induction solution: (A; CD)

A B

2
2
C D
C D

3, 1 -1, 2 1, 0 2, 1
3, 3

Applied Game Theory 5


Theorem
 Every extensive-form game of perfect
information maps into a normal-form
game.

Applied Game Theory 6


Predation Game
Entrant

Out
 Backward
In
induction
0, 3 Incumbent solution:
(In; A)
Fight Accommodate

-3, -1 2, 1

Incumbent
Fight Accommodate NE: (Out; F)
Out 0, 3 0, 3
Entrant
In -3, -1 2, 1
(In; A)

Applied Game Theory 7


Subgame Perfect Nash equilibrium
 A pair (or set) of strategies is SPNE if it
induces a Nash equilibrium in every
subgame of the original game.

 Only SPNE: (In; A)

 Theorem: In an extensive game of perfect


information, set of SPNE = set of
backward induction solutions
Applied Game Theory 8
Acting crazy…

 If rival does not enter, the incumbent is


free to do whatever it likes

 In particular, it can threaten to fight

 In which case, the rival is better off staying


out

Applied Game Theory 9


Equilibria…
1. Rival enters, neither firm fights
2. Rival doesn’t enter, incumbent threatens to
fight if it did enter
 Now entry deterrence depends crucially on
the rival’s beliefs about the incumbent’s
response
 If the rival is convinced that the incumbent
will be aggressive, it should not enter
 Since the rival chooses not to enter,
choosing to actually be aggressive is a best
response by incumbent

Applied Game Theory 10


Equilibria…
 Even though it is a dominant strategy for
incumbent to not fight, it can deter entry
by threatening.
 Since in the event of successful
deterrence, the threat is not tested this is
a best response for the incumbent
 If the incumbent can affect the rival’s
beliefs, it is possible to deter entry even
in this framework
Applied Game Theory 11
Equilibria… which one?
 The prospect that a threat (which is
costly to carry out) might succeed in a
situation like this posed a problem for
game theory

 Is there some rational means to choose


between the equilibria?

Applied Game Theory 12


Subgame Perfect Nash Equilibrium
 When presented with any history of the
game (even an unexpected one), players
should choose best responses to future
beliefs

 Formally, we require that players choose


optimizing strategies everywhere in the
game (every subgame)

Applied Game Theory 13


Subgame Perfect Equilibrium
 Nash equilibrium in every subgame
 Not fighting is a dominant strategy for the
incumbent if the rival enters
 Therefore, despite incumbent’s threats to
the contrary
◦ Rival should anticipate that its entry will not
lead to fighting
◦ Therefore, it pays to enter.
 Entry deterrence is not credible
Applied Game Theory 14
Extensive-form games of complete
but imperfect information
1 (Ravi) Stadium Play

Play Stadium Stadium 4, 2 0, 0


Play 0, 0 2, 4

2 (Shalini)

Play Stadium Play Stadium

 You don’t know previous actions chosen


when you move.
 Example – prices/quantities of your rival

Applied Game Theory 15


Looking ahead – extensive-form
games of incomplete information
Nature
[½] [½]
S W
1 1

R R
L L
2

 You know actions chosen, but not who has played it.
 You know price/quantity but not if the firm is low-cost
or high-cost type; you know education chosen but not
worker type
Applied Game Theory 16

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