ECON0027 Lecture notes

Section 2: Games in extensive form

with perfect information
Reading: Osborne: Ch 5, 6, 7

2.1 Example: tic-tac-toe

Consider a well-know game called “tic-tac-toe”. It does not fit well into our model of Normal
form games (or does it?) because the players do not make their decisions simultaneously—they
take turns. Here is a representation of the first two rounds of the game showing all possible
scenarios:

P layer 1

x x
P layer 2 x

x o x x o x x o o x o x x x x
P layer 1 o o x x o o
o o o

In this section we develop tools to study games in which players take turns. The tic-tac-toe
example suggests that a convenient tool to represent the structure of such games is a graph (or,
rather a special case of a graph—a tree).

2.2 Definition
A game in extensive form is Γ =< N, A, X, E, ι, (ui )i∈N >, where
• set of players N = {1, 2, ..., N }
• set of actions A
• set of nodes (or histories) X, including x0 – the initial node or empty history
• any node x = (a1 , a2 , .., ak ) results from this sequence of actions
• A(x) is the set of actions available at x
• set of terminal nodes E, where A(z) = ∅ for z ∈ E
• ι : X\E → N tells us which player chooses an action at node x
• ui : E → R is i’s payoff function
A game is of perfect recall if each player remembers what he did in prior moves, and each
player remembers everything that he knew before. A game Γ is finite if A and X are finite.

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2.3 Example of a game tree
Consider Γ =< N, A, X, E, ι, (ui )i∈N >, where
• N = {1, 2};

• A = {L, R, a, b, C, D};

• X = {∅, L, R, (R, a), (R, b), (R, b, C), (R, b, D)};



 {L, R} if x = x0

{a, b} if x = R
• A(x) =


 {C, D} if x = (R, b)
∅ if x ∈ {L, (R, a), (R, b, C), (R, b, D)}



1 if x ∈ {x0 , (R, b)}

• ι(x) = 2 if x = R

∅ if x ∈ {L, (R, a), (R, b, C), (R, b, D)}


 

3 if x=L 
 1 if x = L

6 
if x = (R, a) 4 if x = (R, a)
• u1 (x) = and u2 (x) =


5 if x = (R, b, C) 

 −3 if x = (R, b, C)
 
0 if x = (R, b, D) 14 if x = (R, b, D)
As you can see from the description above, even a very simple game can have a long and
tedious description. Luckily, we can draw the game tree, which is a more user-friendly represen-
tation of the same game. The game tree is without loss—it contains all the information from
the formal description of the game.

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L R

3,1 2
a b

6,4 1
C D

5,-3 0,14

Note that we have not talked about strategies in the definition of the games in extensive
form. That’s because the strategy in such a game is a more complex, derivative object.

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2.4 Strategies
A pure strategy for player i is a function

si : Xi → A satisfying si (x) ∈ A(x).

As before, Si is the set of pure strategies for i.

If we fix a pure strategy profile s (one pure strategy per each player), this results in a
terminal node z ∈ E and it gives rise to payoff for each player (Why?). Note that (Si , ui )i∈I is
the strategic (or normal) form of Γ. We can therefore analyze Γ by analysing its strategic form

2.5 Mixed and behavioral strategies

1
L R

3,1 2
a b

6,4 1
C D

5,-3 0,14

In the example above:

• A set of pure strategies for player 1: {LC, LD, RC, RD}

• A mixed strategy is a vector of probabilities σ = (σLC , σLD , σRC , σRD )

• A behavioral strategy is two vectors of probabilities: (σL , σR ), (σC , σD ). Randomization

between L and R is independent from randomization between C and D

With perfect recall mixed and behavioral strategies are equivalent. We will use behavioral
strategies because they are more convenient (Why?). Whenever, in the contest of an extensive
form game, we use term “mixed strategy”, what we really mean is “behavioral strategy”.
Formally, a behavioral strategy of player i is

σi : Xi → ∆(A) satisfying supp(σi (x)) ⊂ A(x)

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2.6 Example: entry deterrence game
E
OUT IN

0,2 I
A F

1,1 -1,-1

Entrant has one decision node and two choices. Two strategies corresponding to two choices,
SE = {IN, OU T }
Incumbent has one decision node and two choices. Two strategies corresponding to two
choices, SE = {A, F }. The normal form of this game is depicted below

A F
IN 1,1 -1,-1
OUT 0,2 0,2

There are two (pure strategy) Nash equilibria: (IN, A) and (OU T, F ). Consider these two
equilibria in the context of the original game, not its normal form. Equilibrium (OU T, F ) makes
little sense. To exclude equilibria like (OU T, F ) (which are called equilibria with non-credible
threats), we need an equilibrium notion that takes into account that the past cannot be changed.

2.7 Backward induction

A node x is penultimate if every action in A(x) results in a node belonging to E
Backward induction:

• At any penultimate node x, let ι(x) select an action that maximizes her payoffs

• Let ux be the resulting payoff vector. Delete all the branches following x, and assign payoff
vector ux to x

• This gives rise to new game tree Γ1 . Repeat this procedure until every node has been
assigned an action.

This procedure results in backward induction (pure) strategy profile.

Let us come back to our example. The strategy profile highlighted in red is the backward
induction one.

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 E
OUT IN

0,2 I
A F

1,1 -1,-1

2.8 Backwards induction and NE

Theorem 1 If s is a backward induction strategy profile of a game of perfect information Γ, then
s is a Nash equilibrium of Γ. Moreover, pure strategy NE exist in games of perfect information.

Proof By contradiction suppose s is BISP but not NE. Then ∃i ∈ N and ŝi ∈ Si such that

ui (si , s−i ) < ui (ŝi , s−i )

Start from penultimate nodes and see if ŝi and si are different there (in terms of payoffs):

• If yes, we arrived at a contradiction because si selects the highest payoff at penultimate

nodes.

• If not remove all branches from penultimate nodes and raise the payoffs generated by si
(or ŝi since they are the same) to these nodes.

This procedure obtains a new game. Repeat the same steps until we arrive at a contradiction.
Q.E.D.

2.9 Simultaneous moves

Consider the quality choice game from the previous section. This is a normal form game:

Firm
H(igh) L(ow)
Consumer B(uy) 2, 2 −1, 3
N (o) 0, 0 0, 1

Can we rewrite it in a extensive form without loosing the feature of simultaneous moves?
We can, but we need to introduce one more tool: an information set. Let us start with the
following extensive form:

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 C

B N

F F
H L H L

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

Clearly, this is not an accurate representation of the quality choice game because the firm can
condition its choice on the choice of the consumer in the extensive form above. However, if we
assume that the firm cannot distinguish between histories B and N , we would get an accurate
representation. To do that we put two histories—B and N —into a single information set.
The firm knows that the history is either B or N , but cannot tell which one exactly:

B N

F F
H L H L

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

Can we draw a different, yet equivalent representation? Does the order of players matter in
this case?

2.10 Incorporating simultaneous moves into an extensive form game

Here is a more complex example: a quality choice game with investment:

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

H L H L
F F

B N

NI

B N

F F
H L H L

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

2.11 Subgames
An information set is the collection of nodes that satisfy the following three conditions:

1. In all these nodes the same player (denote him by i) is taking an action;

2. The player i does not know in which node of the information set he is;

3. Naturally, the set of actions that is available in two nodes of the same information set is
the same: if x1 and x2 belong to the same information set then A(x1 ) = A(x2 ).

Take a node (a history) x and consider a subtree of the game that follows x. If all the

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information sets that intersect this subtree are contained in this subtree, then node x gives rise
to a subgame.

2.12 Subgame perfect Nash equilibrium

A subgame perfect Nash equilibrium of a game Γ is a strategy profile s∗ that is a Nash equilibrium
in every subgame of Γ.

Theorem 2 A pure strategy profile s∗ is a subgame perfect Nash equilibrium of a game of perfect
information Γ if and only if it is a backward induction strategy profile of this game.

2.13 One-step deviation principle

One-step deviation principle If there exists a profitable deviation from a strategy profile s
for player i, there exists a subgame in which there exists a ”one-step” profitable deviation from
a strategy profile s for player i—i.e., a deviation that involves changing only one action.

1
A B

3,1 2
a b

6,4 1
C D

5,-3 0,14

In this example, player 1 has a profitable deviation from a strategy profile ((A, D), b): player
1 can increase his payoff from 3 to 5 by deviating to a strategy (B, C). The one-step deviation
principle tells us that there is a subgame induced by history (B, b) that has a profitable “one-
step” deviation from action D to action C.

2.14 Example: Stackelberg competition

Two firms move sequentially.
Demand: P = 90 − Q.
The second firm observes the choice of the first firm and makes a decision using this extra
information:
max (90 − q1 − q2 )q2
q2

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 First order condition gives us:
90 − q1
q2 (q1 ) =
2
The first firm anticipates that firm 1 will react this way and takes this reaction into account:

max (90 − q1 − q2 (q1 ))q1

q1

If we plug in the best reply of firm 2 in firm 1’s problem we gets

 
90 − q1
max q1
q1 2
First order condition gives us:
q1∗ = 45
and
q2∗ = 22.5

2.15 Example: Vote Buying

Legislature with k members, k is odd for simplicity
Two rival bills, X and Y
Two interest groups:
• X favours X: it attaches value VX to X being passed and value 0 to Y being passed

• Y favours Y : it attaches value 0 to X being passed and value VY to Y being passed

A game:
Each group sequentially offers individual payments to legislators conditional on tehm voting
for the preferred bill:
• X announces schedule of contingent payments to each legislator (x1 , x2 , ..., xk )

• Y observes the offers made by X and announces a schedule (y1 , y2 , ...., yk )

2.15.1 Vote Buying: Payoffs

Legislator i votes for X if xi > yi , and votes for Y otherwise.
Payoff to X is
( k ) k
X k X
VX I ∆i > − xi ∆i
i=1
2 i=1

where ∆i = 1 if i voted for X, and zero if i voted for Y

If bill Y is passed, payoff to Y is
( k ) k
X k X
VY I ∆i < − yi [1 − ∆i ]
i=1
2 i=1

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2.15.2 Vote Buying: k = 3, VY = 300
At stage 2, Y can win by buying off 2 cheapest legislators
Let x1 , x2 be the lowest two values of payments by X
Y buys if and only if x1 + x2 < 300.
At stage 1, X can win most cheaply by setting

x1 = x2 = x3 = 150
X will do so only if VX > 450.
To summarize:
• If VX > 450, X promises 150 to each legislator and wins. Y offers nothing.

• If VX < 450, X promises nothing. Y pays nothing and bill Y gets passed.

2.15.3 Vote Buying: General case

Let µ denote the bare majority of the legislators
k+1
µ=
2
Since Y will try to undercut µ most under-paid by X legislators, the best strategy for X is
to make equal payments.
If X makes an equal payment of c to each legislator, then X can win only if

µc ≥ VY
or
VY
c≥
µ
But this must be profitable for X, i.e.

kc ≤ VX
or
kVY
≤ VX
µ
If the latter condition is satisfied, X pays VµY to each legislator, and Y pays nothing, and X
gets passed.
If not, then X pays nothing, Y pays nothing, and Y gets passed.

2.16 Rubinstein-Stahl bargaining solution

Two players are dividing a dollar using the following protocol:

• At odd periods, player 1 is proposing a division (x,1-x).

• Player 2 either accepts it or not.

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 • If the division is accepted, the game ends and players get their shares of the dollar.
• If the division is not accepted the game continues to the next (even) period in which the
players switch their roles: Player 2 is proposing the division and player 1 either accepts or
rejects it.

Players disounts their future payoffs with discount factors δ1 and δ2 .

2.16.1 How to find SPNE?

• Infinitely many subgames: sort them in classes
• Each subgame is infinite: use one-step deviation principle
• Many possible strategy profiles: use payoffs as a state variable (value functoins)

2.16.2 Value functions

Two classes of subgames: Player 1 is a proposer and player 2 is a proposer. Subgames within a
class are strategically identical to each other.

• Let v i be the maximum (supremum) equilibrium payoff of a player i in a subgame in which

he is a proposer and
• let wi be his maximum (supremum) eq. payoff in a subgame in which his opponent is
proposing.
• Let v i be the minimum (infinum) equilibrium payoff of a player i in a subgame in which
he is a proposer and
• let wi be his minimum (infinum) eq. payoff in a subgame in which his opponent is propos-
ing.

Clearly, v i ≥ v i and wi ≥ wi .

2.16.3 Proposals
• The sum of the payoff cannot exceed 1 because the players are dividing 1 dollar:

v 1 + w2 ≤ 1 (1)

v 2 + w1 ≤ 1 (2)

• Player 1 can always offer δ2 v 2 and this offer will be accepted:

v 1 ≥ 1 − δ2 v 2 (3)

• Player 1 can always reject all offers

w1 ≥ δ1 v 1 (4)

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2.16.4 Bounds on v and v
• Start with inequality (3) and plug in (1) and then (4):
v 1 ≥ 1 − δ2 v 2 ≥ 1 − δ2 + δ2 w 1 ≥ 1 − δ2 + δ2 δ1 v 1
Solving for v 1 we get
1 − δ2
v1 ≥ (5)
1 − δ1 δ2
• Start with inequality (1) and plug in (4) and then (5):
1 − δ1
v 1 ≤ 1 − w 2 ≤ 1 − δ2 v 2 ≤ 1 − δ2
1 − δ1 δ2
Solving for v 1 we get
1 − δ2
v1 ≤ (6)
1 − δ1 δ2
• Combine (5) and (6) together to get
1 − δ2 1 − δ2
≤ v1 ≤ v1 ≤
1 − δ1 δ2 1 − δ1 δ2
from which we conclude that
1 − δ2
v1 = v1 = (7)
1 − δ1 δ2
• Similarly for agent 2
1 − δ1
v2 = v2 = (8)
1 − δ1 δ2

2.16.5 Bounds on w1 and w1

• From (4) and (7) :
δ1 (1 − δ2 )
w1 ≥ (9)
1 − δ1 δ2
• From (2) and (8):
δ1 (1 − δ2 )
w1 ≤ 1 − v 2 = (10)
1 − δ1 δ2
• Combine (9) and (10) together to get
δ1 (1 − δ2 ) δ1 (1 − δ2 )
≤ w1 ≤ w1 ≤
1 − δ1 δ2 1 − δ1 δ2
from which we conclude that
δ1 (1 − δ2 )
w1 = w1 =
1 − δ1 δ2
• Similarly for agent 2
δ2 (1 − δ1 )
w2 = w2 =
1 − δ1 δ2

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2.16.6 Unique equilibrium
• Since w1 + v2 = w2 + v1 = 1, there is no delay and the dollar is divided immediately

• When agent i is a proposer, he proposes a division (vi , 1 − vi )

• A receiver j accepts if and only if the offer is weakly above wj .

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