Jonathan

Schiller

Game Theory
An intuitive
Approach Interactive Case Study Seminar: Introduction
Prisoner’s Dilemma
A Taxonomy of
Games
to Decision and Game Theory
Normal and
Extensive Form
Games
Solution Concepts

Jonathan Schiller

University of Bayreuth
[email protected]
 Outline

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
1 An intuitive Approach
A Taxonomy of
Games 2 Prisoner’s Dilemma
Normal and
Extensive Form
Games 3 A Taxonomy of Games
Solution Concepts

4 Normal and Extensive Form Games

5 Solution concepts
6 Repeated Games
 Learning Goals

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Games
Normal and
Get an idea about the problems arising when we play
Extensive Form
Games against others
Solution Concepts

Develop solution concepts for games

 Literature

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Games Dixit, A. and Skeath, S. (2004) Games of Strategy. 2nd
Normal and
Extensive Form
Games
edn. Norton. Chps 2-4 (Optional Reading: Chps 1, 11).
Solution Concepts
Rasmusen, E. (2007) Games and Information. 4th edn.
Blackwell. Chp 1.
 An intuitive Approach

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Two branches of decision theory:
Games
Normal and
Extensive Form
1 Parametric decisions (classical decision theory): Games
Games
Solution Concepts
against nature
2 Strategic decisions (game theory): Games against other
rational actors
 An intuitive Approach

Jonathan
Schiller

Game Theory
An intuitive
What changes?
Approach
Prisoner’s Dilemma 1 States are no longer independent of our own decisions!
A Taxonomy of
Games
Normal and 2 Our actions or the fact that we can choose from
Extensive Form
Games
Solution Concepts
alternative actions might influence the other player’s
decisions and thus, our ”states”
3 Example: Chess (too complex for analysis)
4 Basic assumption in all games we will study: common
knowledge of rationality (nth degree)
 Prisoner’s Dilemma

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Example: supermarkets
Games
Normal and
Extensive Form
Games Row/Col Increase Prices Lower Prices
Solution Concepts
Increase Prices (100.000/100.000) (0/120.000)
Lower Prices (120.000/0) (10.000/10.000)
 Prisoner’s Dilemma

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of Classic Prisoner’s Dilemma
Games
Normal and
Extensive Form
Games P1/P2 Confess Not Confess
Solution Concepts
Confess (-10/-10) (-1,-20)
Not Confess (-20/-1) (-2/-2)
 Prisoner’s Dilemma

Jonathan
Schiller

Game Theory
An intuitive
Approach Example: Pollution
Prisoner’s Dilemma
A Taxonomy of
Games
Normal and
Extensive Form
Firm 1/Rest Pollute Don’t Pollute
Games
Solution Concepts
Pollute High Profits and High Profits and
polluted river clean river
Don’t pollute Low profits and Low profits and
polluted river clean river
 Prisoner’s Dilemma

Jonathan
Schiller
In general PDs arise whenever
Game Theory
An intuitive
Approach
a game is symmetrical, i.e. all players face the same
Prisoner’s Dilemma
A Taxonomy of
strategies and outcomes
Games
Normal and
Extensive Form
outcomes are ranked as in the following matrix:
Games
Solution Concepts You/Others Act Don’t Act
Act (2/2) (4/1)
Don’t Act (1/4) (3/3)
The PD holds true even if we assume that agents can
communicate and even if we loosen the common
knowledge of rationality axiom
 A Taxonomy of Games

Jonathan
Schiller

Game Theory
An intuitive
1 Zero-sum vs nonzero-sum games
Approach
Prisoner’s Dilemma 2 Non-cooperative vs cooperative games
A Taxonomy of
Games
Normal and
3 Simultaneous-move vs sequential-move games
Extensive Form
Games
Solution Concepts
4 Games with perfect information vs Games with imperfect
information (complete, perfect, symmetric)
5 Non-symmetric vs symmetric games
6 Two-person vs n-person games
7 Non-iterated vs iterated games
 Normal and Extensive Form Games

Jonathan
Schiller

Game Theory
An intuitive
Approach
Definition (Normal (Strategic) Form Game (NFG))
Prisoner’s Dilemma
A Taxonomy of
Games
The normal form representation of an n-player game specifies
Normal and
Extensive Form
the players’ strategy spaces and their payoff functions:
Games
Solution Concepts
G=[S1 ,...,Sn ; π1 ,...,πn ]
Represented by a game matrix
Each player can have at most one opportunity to act
(might be sequential!)
 Jonathan
Schiller
Definition (Extensive Form Game (EFG))

Game Theory
The extensive form (or game tree representation) of an n-player
An intuitive
game specifies:
Approach
Prisoner’s Dilemma The configuration of decision nodes which are nodes at which some
A Taxonomy of
Games player (incl. Nature being a pseudo-player) performs an action
Normal and
Extensive Form
(branch) and terminal nodes which are nodes at which the game ends
Games
Solution Concepts An indication of which nodes belong to which player
The probabilities that Nature uses to choose different branches from
each of its decision nodes
The information that each player has concerning at which decision
node he currently is at
The payoffs for each player at each terminal node
The strategies of each player: the actions that a player chooses for
every history after which it is his turn to move
 Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Games
Normal and
Extensive Form
Games
Solution Concepts
 Solution Concepts

Jonathan
Schiller

Game Theory
An intuitive
We want to know what the solution of a game is, i.e. we
Approach
Prisoner’s Dilemma
want to know the best strategy to play when we are in a
A Taxonomy of
Games game
Normal and
Extensive Form
Games
There are several solution concepts we might want to
Solution Concepts consider:
Maximin
Dominance
Nash Equilibrium
Rollback Equilibrium (Sub-game perfect Equilibrium)
...
 Maximin?

Jonathan
Schiller

Game Theory
An intuitive A/B S1 S2
Approach
Prisoner’s Dilemma S1 (0/0) (-10/10)
A Taxonomy of
Games S2 (-100/0) (20/10)
Normal and
Extensive Form
Games
Solution Concepts
 Maximin?

Jonathan
Schiller

Game Theory
An intuitive A/B S1 S2
Approach
Prisoner’s Dilemma S1 (0/0) (-10/10)
A Taxonomy of
Games S2 (-100/0) (20/10)
Normal and
Extensive Form
Games
Solution Concepts Maximin leads to irrational results! If A knew that B would
play S2 he would play S2 as well. The problem is that using
Maximin, the player has to believe that his opponent would
choose the strategy that hurts him the most, even if that
strategy is not in player B’s self-interest! Hence, Maximin
implies inconsistent beliefs!
 Dominance?

Jonathan
Schiller

Game Theory Definition (Strict Dominance)

An intuitive
Approach
Prisoner’s Dilemma A strategy is strictly dominant if it is player i’s strictly best
A Taxonomy of
Games
Normal and
response to every strategy other players could choose
Extensive Form
Games
Solution Concepts
Definition (Weak Dominance)
A strategy is weakly dominant if it is a player’s best response
to every strategy the other players might pick in the sense that
for at least one contingency this strategy is strictly better while
for others it is as least as good as another available strategy
 Dominance?

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Games A/B S1 S2
Normal and
Extensive Form
Games
S1 (-2/-2) (-10/0)
Solution Concepts
S2 (0/-10) (-5/-5)
 Dominance?

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Games A/B S1 S2
Normal and
Extensive Form
Games
S1 (-2/-2) (-10/0)
Solution Concepts
S2 (0/-10) (-5/-5)

PD is a classical example for strict dominance!

 Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A/B S1 S2
A Taxonomy of
Games
S1 (10/0) (5/2)
Normal and
Extensive Form
S2 (10/1) (2/0)
Games
Solution Concepts
 Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A/B S1 S2
A Taxonomy of
Games
S1 (10/0) (5/2)
Normal and
Extensive Form
S2 (10/1) (2/0)
Games
Solution Concepts
S1 weakly dominates S2. Knowing that A will play S1, B will
play S2 as 2>0.
However, in some cases we will not be able to find dominant
strategies!
 Nash Equilibrium

Jonathan
Schiller

Game Theory
An intuitive
Approach
Problem: Find a stable strategy combination (equilibrium)
Prisoner’s Dilemma even if there is no dominant strategy
A Taxonomy of
Games
Normal and Idea: Nash Equilibrium
Extensive Form
Games
Solution Concepts
Definition (Nash Equilibrium (NE))
A strategy profile is a Nash Equilibrium if no player has an
incentive to unilaterally deviate from its strategy, given that the
other players do not deviate
 Nash Equilibrium

Jonathan
Schiller
A pair of strictly dominant strategies is a NE (e.g. PD)
Game Theory
An intuitive
Approach
BUT: not every NE is in strictly dominant strategies!
Prisoner’s Dilemma
A Taxonomy of A/B S1 S2
Games
Normal and
Extensive Form
S1 (2/2) (0/0)
Games
Solution Concepts
S2 (0/0) (2/2)
Difference:
Strict dominance: Player i is doing the best he can
independent of player j’s strategies
NE: Player i is doing the best he can given the strategy
choice of Player j, while player j is doing the best he can
given the strategy choice of player i
 Nash Equilibrium

Jonathan
Schiller
Every Game has at least one NE (might be in mixed
Game Theory
An intuitive
strategies, that are not of interest here)
Approach
Prisoner’s Dilemma Games very often have multiple NE. But what to do if we
A Taxonomy of
Games face many equilibria with different outcomes?
Normal and
Extensive Form
Games
Solution Concepts S1 S2 S1 S2 S1 S2
S1 2,1 0,0 2,2 -1,-1 2,2 0,0
S2 0,0 1,2 -1,-1 1,1 -9,0 1,1

We still need a more specific concept! However, in some

situation we just can’t find a real solution...
Sub-game Perfectness (for sequential games)
Trembling Hand Sub-game Perfectness
 Rollback (Sub-Game Perfect) Equilibrium

Jonathan
Schiller
Definition (Sub-Game)
Game Theory A sub-game is part of a sequential game that begins at a
An intuitive
Approach
Prisoner’s Dilemma
particular decision node of the original game
A Taxonomy of
Games The game tree for the sub-game is then just that part of
Normal and
Extensive Form
Games
the game tree for the full game that takes this node as its
Solution Concepts root

Definition (Sub-Game Perfect Equilibrium)

A sub-game perfect equilibrium (SPE) is a refinement of a

NE used in sequential games
A strategy profile is a SPE if it represents a NE of every
sub-game of the original game
 Rollback (Sub-Game Perfect) Equilibrium

Definition (Rollback Equilibrium)

Jonathan
Schiller
When all players choose their strategies found by doing rollback
Game Theory analysis, we call this set of strategies the rollback equilibrium of the
An intuitive
Approach
game
Prisoner’s Dilemma
A Taxonomy of
Games Definition (Rollback Analysis)
Normal and
Extensive Form
Games The rollback analysis looks ahead and is reasoning backwards to
Solution Concepts
determine behavior in sequential move games (with perfect
information!)
1 At first only consider decision nodes that directly lead only to
terminal nodes
2 Choose the payoff maximizing strategy
3 The considered decision nodes can now be interpreted as
terminal nodes
4 Repeat until the whole game is solved
 Rollback (Sub-Game Perfect) Equilibrium

Jonathan
Schiller

Game Theory
An intuitive
Approach
Prisoner’s Dilemma
A Taxonomy of
Games
Normal and
Extensive Form
Games
Solution Concepts