Introduction to

Game Theory (I) Description of a Game

 The set of players
 Description of a game
 The strategies of players
 Classification of games
 The payoffs of players as functions of players’
 Normal form and Extensive form
strategies
 Nash Equilibrium
 Subgame perfect Nash equilibrium

 Examples

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Equilibrium Concepts Two Ways to

of Games Formalize a Game
 Normal form
Static Dynamic  Extensive form

Complete Subgame perfect

Nash
Nash
Information Equilibrium
Equilibrium
Incomplete Bayesian Perfect Bayesian
Information Equilibrium Equilibrium
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 Prisoner’s Dilemma
The Normal Form of a Game (Normal Form)
 It shows the “Pure strategies” of players;
 It shows the payoffs as functions of players’ pure Cooperate Not cooperate
Player1\Player 2
strategies (C) (D)

Cooperate (C) (2,2) (-3, 3)

Not Cooperate (D) (3, -3) (-2,-2)

5 Is there any dominant strategy for each player? 6

Second-price
Sealed Bid Auction Extensive Form
of a Game
 N bidders with valuations
0<v1< v2 < v3 ……. < vN submit their bids 𝑏  Order of play
simultaneously for an object.  Information and choices available to a player
 The highest bidder wins the object but pays the  Payoffs of players
second bid.
 If bidder i wins, then his payoff equals

𝜋 = 𝑣 − max 𝑏 ; Otherwise, 0.
 What would be the equilibrium?
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 Is there any dominant strategy for each bidder?

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 What would be the equilibrium
Predation Game
outcome?
 An entrant (E) decides to enter (In) or not;  The payoffs (x, y) where x is E’s payoff are as follows:
 Then the incumbent (I) predates or not; E is out  (0, 3/4)
 I threatens to predate E whenever E is in. E In and I predates  (-1, -1)
E In and I not predate  (1, 0)
 What is the extensive form of this game?

 What is the normal form of this game?

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Shan-Yu Chou Shan-Yu Chou

Game 1
Game 1
(Extensive Form)
 Player 1 moves first and chooses L or R1;
 Player 2, after observing player 1’s choice,
chooses l or r2. The payoff profiles are the same
as in game 2.
 What is the extensive form of game 1?
 What is the normal form of game 1?

1L can be choosing a low price, and R can be choosing a high price, for
example.
2l can be choosing a low price, and r can be choosing a high price, for 11 12
example.

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 Pure Strategies and Mixed Game 1
Strategies (Normal Form)

 A pure strategy has to be a complete description of 1\2 (l,l) (r,r) (l,r) (r,l)
a player’s actions taken throughout the game;
 A mixed strategy is a probability distribution over L 2,0 2,-1 2,0 2,-1
the set of pure strategies.
R 1,0 3,1 3,1 1,0

What are the Nash equilibria (to be defined)?

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Game 2
Nash Equilibrium (NE)
 Player 1 and player 2 move simultaneously;
 Player 1 chooses L or R and player 2 chooses l or r.
 A pure strategy Nash equilibrium is a set of
The payoff profiles are the same as game 1.
actions such that no player, taking his
 The following is the normal form of the game: opponents’ actions as given, wishes to change
his own actions.
Player 1 \ 2 l r
 What are NE(s) for game 1, and game 2,
L (2, 0) (2, -1) respectively?
R (1, 0) (3, 1)

What is the extensive form of game 2? 15 16

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 Matching Pennies Cournot Game With
Simultaneous Moves
Player1\Player 2 H T
 P(Q)=1-Q, where Q=q1+q2
H (1,-1) (-1, 1)  Two firms choose q1 and q2 simultaneously.

 What are their Reaction functions?

 What would be the equilibrium?

T (-1, 1) (1,-1)

Is there any pure strategy Nash equilibrium?

Mixed strategy Nash equilibrium?
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Cournot Game with

Reaction Functions of the two firms Sequential moves
 The profit function of firm 2:
max(1 − 𝑞 − 𝑞 )𝑞  P(Q)=1-Q, where Q=q1+q2
 Firm 1 moves first by choosing q1
 The first order condition with respect to 𝑞 :  Firm 2 chooses q2 after observing q1.
1 − 𝑞 − 𝑞 +𝑞 (-1)=0  What would be the reaction function of firm 2?
 The reaction function of firm 2:
 What would be the equilibrium?
𝑞 = .  Compare it with its counterpart with

 Similarly, the reaction function of firm 1: simultaneous moves.

𝑞 =
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 What would be a Nash equilibrium?

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Targeting at Loyals or Switchers Positioning Game
Valuation Valuation  Two firms choose the positions of their products
Segment Proportion along [0,1] simultaneously.
for A for B
Loyal to  Consumers’ ideal points are uniformly
0.5 2 0 distributed.
A
 Each consumer chooses the product whose
Loyal to
0.2 0 2 position is closest to his ideal point.
B
 Minimum or maximum differentiation?
Switchers 0.3 1.5 1.5

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Is there any pure strategy Nash equilibrium in price?

Positioning Game (Cont.) Perfect Equilibrium

 What if there are 3 firms choosing their positions
simultaneously?  A refinement of Nash equilibrium for dynamic
games
 Is (1/2,1/2, 1/2) a Nash equilibrium?
 A perfect equilibrium is a set of strategies such that
 What if there are 4 firms?
in any subgame the strategies form a Nash
equilibrium (Selten 1965).
 The equilibrium can be derived by backward
induction.
Q: Are all three NE’s in game 1 also perfect equilibria?
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 Games of Almost Perfect
Subgames
Information
 A subgame is the remainder of a game tree starting  Repeated games
from some singleton information set.
 Repeated game of prisoner’s dilemma.
 How many subgames for game 1?

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Example 1
Channel Competition
Valuation for Valuation for
 Two firms (A&B) with a single channel first Segments Proportion A’s product B’s product if
if accessible accessible
choose whether to expand into the other channel
simultaneously; Loyal to A I-users 0.3 $2 0
 After observing their rival’s channel decision, the I-users 0.15
Loyal to B 0 $2
two firms then set prices simultaneously; T-users 0.2
 T-users can only access the traditional channel I-users 0.15
Switchers $0.8 $0.8
(T-channel) while I-users can access both T- T-users 0.2
channel and the Internet channel (I-channel).
A: currently a pure-click company; B: currently a pure-brick company.
Loyal customers only consider the brand they are loyal to.
27 What would be the equilibrium in channels and in prices? 28
First consider the subgame where firm B adopts dual channels while firm
A adopts online channel only, i.e., (I, I+T) channel structure.

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 Example 2
SPNE for Example 2
Valuation for
Valuation for
Valuation for A’s acceptable
Segments Proportion product products sold
B’s  Suppose the two firms can choose whether to adopt
product sold at multi-channel pricing.
sold at I-channel at
I-channel
T-channel
 Suppose switching I-users is willing to pay a higher
Loyal to
A
I-users 0.3 $2 2 0 price ($1.3 instead of $0.8) for a brand sold at both
I-users (0.15) 0 2 x=2 channels.
Loyal to
B T-users (0.2) 0 2 0  Suppose that the two firms will not expand into the
$1.3 if sold at other channel unless doing so gives them a strictly
$1.3 if sold at
I-users 0.15
both
both channels;
$1.3 higher profit.
channels;
Switchers $0.8, otherwise.  Derive a SPNE in channel and in prices.
$0.8, otherwise.
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T-users 0.2 0 $0.8 0

Consider Channel Choice (I, I+T)

Voting Game
(Example 2)
 Three players (1, 2 &3) vote for three alternatives, A,
 What if B’s loyal I-users prefer to purchase its product offline B and C. Alternative B is the “status quo”. At the
and is only willing to pay 1.5 instead of 2, if purchasing B’s first stage, each player chooses one between A and C.
product online (i.e., x=1.5)?
The majority choice will be the winner.
 Derive a Nash equilibrium in price under (I, I+T) and the
associated equilibrium profits for the two firms.  At the second stage, players vote between B and the
 Suppose firm B adopts self-matching policy in the beginning winning alternative in the first round. Again, the
where consumers can request firm B to honor a lower price majority choice is the winner.
set at its other channel by providing the associated evidence.  Players vote simultaneously in each round. The
Derive a Nash equilibrium in price under (I,I+T) and the
payoff of each player depends only on the final
equilibrium profit.
alternative selected.
 Should B adopt self-matching policy?
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 Voting Game (Cont.)
Player\alternative A B C
1 2 0 1
2 1 2 0
3 0 1 2
 The payoff functions are as above.
 What if at each stage the players vote for the
alternative they would prefer as the final outcome?
 Derive a SPNE.
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