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Game Theory

Bhaskar Dutta

February 1, 2017

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What is game theory

Game theoretic reasoning pervades economic theory, and now


several other behavioral sciences.

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What is game theory

Game theoretic reasoning pervades economic theory, and now


several other behavioral sciences.
Game Theory aims to help us understand situations in which
decision-makers interact

Bhaskar Dutta Game Theory February 1, 2017 2 / 21


What is game theory

Game theoretic reasoning pervades economic theory, and now


several other behavioral sciences.
Game Theory aims to help us understand situations in which
decision-makers interact
This implies that one agents actions influence other peoples
actions.

Bhaskar Dutta Game Theory February 1, 2017 2 / 21


What is game theory

Game theoretic reasoning pervades economic theory, and now


several other behavioral sciences.
Game Theory aims to help us understand situations in which
decision-makers interact
This implies that one agents actions influence other peoples
actions.
This implies that one agents optimal action depends on what
others are going to do.

Bhaskar Dutta Game Theory February 1, 2017 2 / 21


What is game theory

Game theoretic reasoning pervades economic theory, and now


several other behavioral sciences.
Game Theory aims to help us understand situations in which
decision-makers interact
This implies that one agents actions influence other peoples
actions.
This implies that one agents optimal action depends on what
others are going to do.
Agent 1 has to predict or conjecture what other players will do,
knowing that her own action will influence their choices - strategic
interaction

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Examples of Strategic Interaction

Penalty kicks in soccer


Oligopoly versus perfect competition.
Political candidates competing for votes
Bidders bidding in an auction.

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Description of a game

The set of players


a complete description of what players can do
a description of what the players know when they have to move
a specification of how players actions lead to outcomes
specification of players preferences over outcomes

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Examples of games

Chess
Matching pennies

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The Extensive Form

Focus on two formal representations - extensive form


representation and normal form representation
Extensive form representation -use a (game) tree.
Tree defined by nodes and branches.
Nodes are of two types - non-terminal and terminal
Non-terminal Nodes represent places where a player takes a
decision; terminal nodes have outcomes attached to them.
Branches indicate actions that player can take.
Representing information by showing what players know about
where they are when they move.

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Example

Price competition between two firms.


Firm 1 moves first, and can choose either a high or low price.
Firm 2 moves second, also has to choose a high or low price.
Payoffs - if both firms choose H, then payoffs are (1.1).
If both firms choose L, payoffs are (1/2, 1/2)
Otherwise, payoffs are (0,2), with firm choosing L getting ).
Crucial : does firm 2 know what 1 has chosen

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Strategies

More detail about strategies and normal form


Definition
A strategy is a complete contingent plan description for a player in the
game.

In the extensive form game, a strategy must specify what player i


does AT EVERY INFORMATION SET.
Si will denote the strategy set of player i.
In the price game where 1 chooses from {H, L}, 2 also chooses
from {H, L} but AFTER observing 1s choice
S1 = {H, L}, S2 = {HH, HL, LH, LL}.
Notation : si = (s1 , . . . , si1 , si+1 , . . . , sn ), s = (si , si ).

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More Examples

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More Examples

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More Examples

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Normal Form Game

More concise representation.


(N, (Si )iN , (ui )iN ).
where N is set of players,
Si set of actions (strategies ) and ui : S < is payoff function of i.

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Extensive and normal form

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Normal Form Game

More concise representation.


(N, (Si )iN , (ui )iN ).
where N is set of players,
Si set of actions (strategies ) and ui : S < is payoff function of i.

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Beliefs and Mixed Strategies

Players have to form beliefs about what strategies opponents will


play.
Take the matching pennies game.
Will she play H or T?
Often, beliefs will take the form of probability assessments.

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We model beliefs as probability distributions over other players
strategy sets.
Let Si denote the set of all probability distributions over Si
Typical element will be denoted i .
j (sj ) is player is belief that j will play sj with probability j (sj ).

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Mixed Strategies

A mixed strategy of player i is the act of selecting strategies


according to a probability distribution over Si .
So, in the MP game, a player may choose H or T will equal
probability.
A generic mixed strategy will be denoted i , which is a probability
distribution over Si .
A pure strategy is a degenerate mixed strategy.

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Expected value

Definition of payoff function can be extended to mixed strategies


by using expected values
X
ui (si , i ) = i (si )ui (si , si )
si Si

Example : compute different expected values in MP game.

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Dominance

Example (Prisoners Dilemma)


C D
C (1, 1) (1, 2)
D (2, 1) (0, 0)
No matter what the column player plays, D gives the row player a
higher payoff than C.
We will say strategy C is dominated by strategy D.
Definition
A pure strategy si of player i is dominated if there is a strategy
i Si such that

ui (i , si ) > ui (si , si ) for all si Si

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In following game, no pure strategy dominates another pure
strategy for row player.
But, consider the mixed strategy of playing U, D with equal
probability. This dominates M.
L R
U (2, 1) (1, 0)
M (0, 0) (0, 2)
D (1, 1) (2, 0)
Playing a dominated strategy cannot be rational.
What about Prisoners Dilemma game?

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Best Response

Rational players form beliefs about one anothers behaviour (i.e.


choice of strategy).
A B
A (1, 3) (0, , 0)
B (0, 0) (3, 1)
In this coordination game, if i expects j to play A, then i will play A.
Similarly, if she expects her to play B, then she should play B.
Definition
If i has a belief i Si about the strategies played by others, then
si is a best response if ui (si , i ) ui (si0 , i ) for every si0 Si .

Examples

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