Game Theory Lecture 1

Game Theory
Static Games and Nash Equilibrium

Details
• Email: [email protected]
• Homework: recommended but not mandatory
• Grade: based on the final exam
• Textbook: An Introduction to Game Theory (Osborne)
• All lectures will be recorded
• Presentations and homework can be found on moodle
A Simple Strategic Situation
• Two firms must decide whether to produce a small/large output:
Firm 2 Small Large
Firm 1
Small 72,72 60,80
Large 80,60 65,65
• What will happen?

• Depends on our assumptions…
Second Price Auction
• You participate in a 2nd price auction and must choose your bid.
• The object is worth 100$ to you.
• You don’t know how much it is worth to the other bidders.
• How much will you bid?
What is the optimal bid?
• In an auction, one’s bid affects:
• The probability of winning
• The payment conditional on winning
• But in a 2nd price auction the bid does not affect the payment
conditional on winning (one pays the second highest bid).
• Bidding your true value is a dominant strategy

Comment: Common Value Auctions
• In a common value auction, bidding your true valuation is not a
dominant strategy.
• Due to the winner’s curse, bidders should adjust their bid downwards
Comment: Manipulation
Successive Elimination
• Suppose that you are player 1. What will you play?
A B C D
‫א‬ 5,2 2,6 1,4 0,4
‫ב‬ 0,0 3,2 2,1 1,1
‫ג‬ 7,0 2,2 1,5 5,1
‫ד‬ 9,5 1,3 0,2 4,8
Successive Elimination Cont’d
A B C D
‫א‬ 5,2 2,6 1,4 0,4
‫ב‬ 0,0 3,2 2,1 1,1
‫ג‬ 7,0 2,2 1,5 5,1
‫ד‬ 9,5 1,3 0,2 4,8
Playing “A” is not a good idea for player 2. It yields a lower payoff relative to playing
“D”
Successive Elimination: Step 2
A B C D
‫א‬ 5,2 2,6 1,4 0,4
‫ב‬ 0,0 3,2 2,1 1,1
‫ג‬ 7,0 2,2 1,5 5,1
‫ד‬ 9,5 1,3 0,2 4,8
Playing “‫ ”א‬is not a good idea for player 1. It yields a lower payoff relative to playing
“‫”ב‬
Playing “‫ ”ד‬is not a good idea for player 1. It yields a lower payoff relative to playing “‫”ג‬
A B C D
‫א‬ 5,2 2,6 1,4 0,4
‫ב‬ 0,0 3,2 2,1 1,1
‫ג‬ 7,0 2,2 1,5 5,1
‫ד‬ 9,5 1,3 0,2 4,8
Playing “D” is not a good idea for player 2. It yields a lower payoff relative to playing
“B”
A B C D
‫א‬ 5,2 2,6 1,4 0,4
‫ב‬ 0,0 3,2 2,1 1,1
‫ג‬ 7,0 2,2 1,5 5,1
‫ד‬ 9,5 1,3 0,2 4,8
Playing “‫ ”ג‬is not a good idea for player 1. It yields a lower payoff relative to playing
“‫”ב‬
A B C D
‫א‬ 5,2 2,6 1,4 0,4
‫ב‬ 0,0 3,2 2,1 1,1
‫ג‬ 7,0 2,2 1,5 5,1
‫ד‬ 9,5 1,3 0,2 4,8
Playing “C” is not a good idea for player 1. It yields a lower payoff relative to playing
“B”
Comments
• The order in which we delete strategies does not matter when
strategies are strictly dominated.
• The order does matter when we delete strategies that are weakly
dominated.
• This method may not lead to a solution…
• In reality, people depth of reasoning is limited
• Example: p-beauty contest
• Guess ½ the average guesses (between 0 and 100).
Nash Equilibrium
• The most famous solution concept in game theory
• The underlying ideas: self-enforcing agreement, long-run learning,
steady state
• Formally: A profile of strategies is a Nash equilibrium if no player has a
profitable deviation
Bertrand Competition
• Two firms
• Marginal costs:
• Consumers purchase from the cheapest firm.
• Find the Nash equilibrium of the game
Hoteling Location Model
• Two competitors choose where to locate their stores
• One street
• Consumers buy from the nearest seller
• Where would you locate your store?
The Ultimatum Game
• Player 1 offers how to divide a “pie”
• Player 2 decides whether to accept the offer
• If she accepts, they share the pie as offered by player 1
• If she rejects, both players receive nothing.
• What would you do as player 1? As player 2?
• What is the NE of the game?
• Is this prediction sensible?
Multiple Equilibria
• BoS:
Player 2 B S
Player 1
B 2,1 0,0
S 0,0 1,2
Public Good
• Each player has to decide how much to contribute:
• If the sum of contributions exceeds , player receives
• Otherwise, they receive .
• First, assume that . What are the NE of the game?
• Second, assume that . What are the NE of the game?
Mixed Strategies
• Matching Pennies:
Player 2 L R
Player 1
L -1,1 1,-1
R 1,-1 -1,1
• There is no Nash Equilibrium in pure strategies

• Equilibrium in mixed strategies

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Game Theory

Static Games and Nash Equilibrium

Firm 2 Small Large

• What will happen?

• Bidding your true value is a dominant strategy

• There is no Nash Equilibrium in pure strategies

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