The Intuitive and Divinity Criterion:

Explanation and Step-by-step examples

EconS 491 - Felix Munoz-Garcia

School of Economic Sciences - Washington State University
The Intuitive and Divinity Criterion

Reading materials

Slides; and
Link on the course website:
http://www.bepress.com/jioe/vol5/iss1/art7/
Only need to read pages 1-6.
The Intuitive and Divinity Criterion

Motivation

Many economic contexts can be understood as sequential

games involving elements of incomplete information.

Signaling games are an excellent tool to explain a wide array

of economic situations:
Labor market [Spence, 1973]
Limit pricing [Battacharya, 1979 and Kose and Williams, 1985]
Dividend policy [Milgrom and Roberts, 1982]
Warranties [Gal-Or, 1989]
The Intuitive and Divinity Criterion

Motivation

Problems with Signaling games: the set of PBE is usually

large.
In addition, some equilibria are insensible (“crazy”).
Hence, how can we restrict the set of equilibria to those
prescribing sensible behavior?
Solutions to re…ne the set of PBE:
Intuitive criterion [Cho and Kreps, 1987] ( easy), and
“Universal Divinity” criterion [Banks and Sobel, 1987] (also
referred as the D1 -criterion)( not for this course. For
references, see links on the course website).
The Intuitive and Divinity Criterion
Description of Signaling Games

Signaling games

One player is privately informed.

For example, he knows information about market demand, his
production costs, etc.
He uses his actions (e.g., his production decisions, investment
in capacity, etc.) to communicate/conceal this information to
other uninformed player.
The Intuitive and Divinity Criterion
Description of Signaling Games

Time Structure

In particular, let us precisely describe the time structure of the

game:
1. Nature reveals to player i some piece of private information,
θ i 2 Θ.
For instance, Θ = fθ L , θ H g .
2. Then, player i, who privately observes θ i , chooses an action
(or message m) which is observed by other player j.
3. Player j observes message m, but does not know player i’s
type. He knows the prior probability distribution that nature
selects a given type θ i from Θ, µ (θ i ) 2 [0, 1].
For example, the prior probability for Θ = fθ L , θ H g can be
µ(θ L ) = p and µ(θ H ) = 1 p.
The Intuitive and Divinity Criterion
Description of Signaling Games

Time Structure

Continues:
4. After observing player i’s message, player j updates his beliefs
about player i’s type.
1 Let µ (θ i jm ) denote player j’s beliefs about player i’s type
being exactly θ = θ i after observing message m.
2 For instance, the probability that player i is a Friendly type
given that he o¤ered me a gift is µ (F jGift )
5. Given these beliefs, player j selects an optimal action, a, as a
best response to player i’s message, m.
The Intuitive and Divinity Criterion
Intuitive Criterion

Outline of the Intuitive Criterion

Consider a particular PBE, e.g., pooling PBE with its

corresponding equilibrium payo¤s ui (θ ).

Application of the Intuitive Criterion in two steps:

1 First Step: Which type of senders could bene…t by deviating
from their equilibrium message?
2 Second Step: If deviations can only come from the senders
identi…ed in the First Step, is the lowest payo¤ from deviating
higher than their equilibrium payo¤?
1 If the answer is yes, then the equilibrium violates the Intuitive
Criterion.
2 If the answer is no, then the equilibrium survives the Intuitive
Criterion.
The Intuitive and Divinity Criterion
Intuitive Criterion

Example 1 - Discrete Messages

Let us consider the following sequential game with incomplete

information:
A monetary authority (such as the Federal Reserve Bank)
privately observes its real degree of commitment with
maintaining low in‡ation levels.
After knowing its type (either Strong or Weak), the monetary
authority decides whether to announce that the expectation for
in‡ation is High or Low.
A labor union, observing the message sent by the monetary
authority, responds by asking for high or low salary raises
(denoted as H or L, respectively)
The Intuitive and Divinity Criterion
Intuitive Criterion

Example 1 - Discrete Messages

The only two strategy pro…les that can be supported as a PBE

of this signaling game are:
A polling PBE with both types choosing (High, High); and
A separating PBE with (Low, High).
Let us check if (High, High) survives the Intuitive Criterion.
The Intuitive and Divinity Criterion
Intuitive Criterion

Example 1 - Discrete Messages

Notice that the pooling PBE prescribes a somewhat insensible

behavior from the Strong monetary authority:
It announces a High in‡ation target for next year.
Let us check if this behavior survives the Intuitive Criterion.
The Intuitive and Divinity Criterion
Intuitive Criterion

First Step

First Step: Which types of monetary authority have

incentives to deviate towards Low in‡ation?
Low in‡ation is an o¤-the-equilibrium message.
Let us …rst apply condition (1) to the Strong type,

uMon (High jStrong ) < max uMon (Low jStrong )

| {z } a
Equil. Payo¤
| Labor {z }
Highest payo¤ from deviating to Low
200 < 300

Hence, the Strong type of monetary authority has incentives

to deviate towards Low in‡ation.
The Intuitive and Divinity Criterion
Intuitive Criterion

First Step

Graphically, we can represent the incentives of the Strong

monetary authority to deviate towards Low in‡ation as follows:
The Intuitive and Divinity Criterion
Intuitive Criterion

First Step

Let us now check if the Weak type also has incentives to

deviate towards Low:

uMon (High jWeak ) < max uMon (Low jWeak )

| {z } aLabor
Equil. Payo¤
| {z }
Highest payo¤ from deviating to Low
150 > 50

Thus, the Weak type of monetary authority does not have

incentives to deviate towards Low in‡ation.
The Intuitive and Divinity Criterion
Intuitive Criterion

First Step

Graphically, we can represent the lack of incentives of the

Weak monetary authority to deviate towards Low in‡ation as
follows:
The Intuitive and Divinity Criterion
Intuitive Criterion

First Step

Hence, the only type of Monetary authority with incentives to

deviate is the Strong type, Θ (Low ) = fStrong g .
Thus, the labor union beliefs after observing Low in‡ation are
restricted to γ = 1. (Not arbitrary, γ 2 [0, 1] , anymore)
The Intuitive and Divinity Criterion
Intuitive Criterion

First Step

This implies that the labor union chooses Low wage demands
after observing Low in‡ation. (0 is larger than 100, in the
upper right-hand node).
The Intuitive and Divinity Criterion
Intuitive Criterion

Second Step
Study if there is a type of monetary authority and a message
it could send such that condition (2) is satis…ed:
min ui (m, a, θ ) > ui (θ ) .
a 2A (Θ (m ),m )

which is indeed satis…ed since 300 > 200 for the Strong
monetary authority.
The Intuitive and Divinity Criterion
Intuitive Criterion

As a result...

The pooling PBE of (High, High) violates the Intuitive

Criterion:
there exists a type of sender (Strong monetary authority) and
a message (Low)
which gives to this sender a higher utility level than in
equilibrium, regardless of the response of the follower (labor
union).
The Intuitive and Divinity Criterion
Intuitive Criterion

Possible speech

Possible speech from the sender with incentives to deviate (Strong

monetary authority):

“It is clear that my type is in Θ (m ) = fStrong g. If my type was

Weak I would have no chance of improving my payo¤ over what I can
obtain at the equilibrium (condition (1)) by selecting Low in‡ation. We
can therefore agree that my type is Strong. Hence, update your believes
as you wish, but restricting my type to be in Θ (m ) = fStrong g.

Given these beliefs, your best response to my message improves my

payo¤ over what I would obtain with my equilibrium strategy
(condition (2)). For this reason, I am sending you such
o¤-the-equilibrium message of Low in‡ation.”
The Intuitive and Divinity Criterion
Intuitive Criterion

Only separating PBE survives

Therefore, there is only one equilibrium in this game that survives

the Intuitive Criterion: the separating PBE with (Low, High)
The Intuitive and Divinity Criterion
Intuitive Criterion

One second. . .

Why can’t we apply the Intuitive Criterion to the above separating

PBE, to test if this equilibrium survives the Intuitive Criterion?
In this separating PBE there is no o¤-the-equilibrium message,
since all messages are used by either type of sender.
Recall that in the Intuitive Criterion we start by checking if a
sender has incentives to deviate towards an o¤-the-equilibrium
message, then we restrict the responder’s o¤-the-equilibrium
beliefs, etc.
The Intuitive and Divinity Criterion
Intuitive Criterion

Insight

This implies that, in signaling games with two types of

senders and two available actions (messages) for the senders,
the separating PBEs always survive the Intuitive Criterion.
What if two types of senders can choose among three possible
messages?
Type t1 sends message m1 ,
Type t2 sends message m2 , and
Nobody sends message m3 !! Then, m3 is an
o¤-the-equilibrium message.
In this case, we can check if this separating PBE
survives/violates the Intuitive Criterion.
The Intuitive and Divinity Criterion
Intuitive Criterion

Beer-Quiche game (Breakfast in the Far West)

Final exam
1 Player 1 just moved into town, and nobody else but him knows
whether he is "Wimpy" or "Surely" (i.e., Weak or Strong).
2 At the moment in the morning the Saloon is a quite place,
and he is deciding what to have for breakfast:
1 Quiche (something that he really enjoys if he is a Wimpy
type), or
2 Beer (something he prefers when he is of the Surely type).
3 Then, player 2 (the typical character looking for trouble in this
kind of …lms) enters into the Saloon and observes the
newcomer having breakfast. . .
1 but does not know whether he is Surely or Wimpy.
The Intuitive and Divinity Criterion
Intuitive Criterion

Beer-Quiche game (Breakfast in the Far West)

Part (a) of the exercise
1 Check if the pooling equilibrium in which both types of player
1 have Beer for breakfast survive the Cho and Kreps’(1987)
Intuitive Criterion.
The Intuitive and Divinity Criterion
Intuitive Criterion

Beer-Quiche game (Breakfast in the Far West)

Part (b) of the exercise
1 Check if the pooling equilibrium in which both types of player
1 have Quiche for breakfast survives the Cho and Kreps’
(1987) Intuitive Criterion.