Motivation Games in strategic form Games in extensive form

Advanced Microeconomics: Game Theory

P. v. Mouche

Wageningen University

Summer 2019
Motivation Games in strategic form Games in extensive form

Outline

1 Motivation

2 Games in strategic form

3 Games in extensive form

Motivation Games in strategic form Games in extensive form

What is game theory?

Traditional game theory deals with mathematical mod-

els of conflict and cooperation in the real world between
at least two rational intelligent players.

Player: humans, organisations, nations, animals,

computers,. . .
Situations with one player are studied by the classical
optimisation theory.
‘Traditional’ because of rationality assumption.
‘Rationality’ and ’intelligence’ are completely different
concepts.
Motivation Games in strategic form Games in extensive form

Nature of game theory

Applications: parlour games, military strategy, computer

games, biology, economics, sociology, psychology
anthropology, politocology.
Game theory provides a language that is very appropriate
for conceptual thinking.
Many game theoretical concepts can be understood
without advanced mathematics.
Motivation Games in strategic form Games in extensive form

Outcomes and payoffs

A game can have different outcomes. Each outcome has

its own payoffs for every player.
Nature of payoff: money, honour, activity, nothing at all,
utility, real number, ... .
Interpretation of payoff: ‘satisfaction’ at end of game.
In general it does not make sense to speak about ‘winners’
and ‘losers’.
Motivation Games in strategic form Games in extensive form

Rationality

Because there is more than one player, especially rationality

becomes a problematic notion.

For example, what would You as player 1 play in the following

bi-matrix-game:
 
300; 400 600; 250
.
200; 600 450; 500

One player chooses a row, the other a column; first (second)

number is payoff to row (column) player.
Motivation Games in strategic form Games in extensive form

Tic-tac-toe

1 2 3
Notations: 4 5 6
7 8 9
Player 1: X. Player 2: O.
Many outcomes (more than three). Three types of
outcomes: player 1 wins, draw, player 1 loses.
Payoffs (example): winner obtains 13 Euro from loser.
When draw, then each player cleans the shoes of the
other. (In fact it is a a zero-sum game.)
Example of a play of this game:
Motivation Games in strategic form Games in extensive form

Tic-tac-toe (cont.)

X X X X

O O
X X O X X O X X O
O
O X O X O
So: player 2 is the winner.

Question: Is player 1 intelligent? Is player 1 rational?

Answer:
Motivation Games in strategic form Games in extensive form

Hex

http://www.lutanho.net/play/hex.html.
Motivation Games in strategic form Games in extensive form

Real-world types

all players are rational – players may be not rational

all players are intelligent – players who may be not
intelligent
binding agreements – no binding agreements
chance moves – no chance moves
communication – no communication
static game – dynamic game
transferable payoffs – no transferable payoffs
interconnected games – isolated games
(In red what we will assume always.)
perfect information – imperfect information
complete information – incomplete information
Motivation Games in strategic form Games in extensive form

Perfect information

A player has perfect information if he knows at each

moment when it is his turn to move how the game was
played untill that moment.
A player has imperfect information if he does not have
perfect information.
A game is with (im)perfect information if (not) all players
have perfect information.
Chance moves are compatible with perfect information.
Examples of games with perfect information: tic-tac-toe,
chess, ...
Examples of games with imperfect information: poker,
monopoly (because of the cards, not because of the die).
Motivation Games in strategic form Games in extensive form

Complete information

A player has complete information if he knows all payoff

functions.
A player has incomplete information if he does not have
complete information.
A game is with (in)complete information if (not) all players
have complete information.
Examples of games with complete information: tic-tac-toe,
chess, poker, monopoly, ...
Examples of games with incomplete information: auctions,
oligopoly models where firms only know the own cost
functions, ...
Motivation Games in strategic form Games in extensive form

Common knowledge

Something is common knowledge if everybody knows it and in

addition that everybody knows that everybody knows it and in
addition that everybody knows that everybody knows that
everybody knows it and ...
Motivation Games in strategic form Games in extensive form

Common knowledge

A group of dwarfs with red and green caps are sitting in a circle
around their king who has a bell. In this group it is common
knowledge that every body is intelligent. They do not
communicate with each other and each dwarf can only see the
color of the caps of the others, but does not know the color of
the own cap. The king says: ”Here is at least one dwarf with a
red cap.”. Next he says: “I will ring the bell several times. Those
who know their cap color should stand up when i ring the bell.”.
Then the king does what he announced.

The spectacular thing is that there is a moment where a dwarf

stands up. Even, when there are M dwarfs with red caps that
all these dwarfs simultaneously stand up when the king rings
the bell for the M-th time.
Motivation Games in strategic form Games in extensive form

Mathematical types

Game in strategic form.

Game in extensive form.
Game in characteristic function form.
Motivation Games in strategic form Games in extensive form

Game in strategic form

Definition
Game in strategic form , specified by
n players : 1, . . . , n.
for each player i a strategy set (or action set) Xi . Let
X := X1 × · · · × Xn : set of strategy profiles .
for each player i payoff function fi : X → R.

Interpretation: players choose simultaneously and

independently a strategy.
Motivation Games in strategic form Games in extensive form

A game in strategic form is called finite if each strategy set Xi

is finite.
In the case of two players a finite game in strategic form can be
represented as a bi-matrix game.
Motivation Games in strategic form Games in extensive form

Some concrete games (ctd).

 
0; 0 −1; 1 1; −1
 1; −1 0; 0 −1; 1 
−1; 1 1; −1 0; 0

Stone-paper-scissors
Motivation Games in strategic form Games in extensive form

Some concrete games (ctd).

Cournot-duopoly :
n = 2, Xi = [0, mi ] or Xi = R+

fi (x1 , x2 ) = p(x1 + x2 )xi − ci (xi ).

p: price function, ci : cost function.

Transboundary pollution game : n arbitrary, Xi = [0, mi ]

fi (x1 , . . . , xn ) = Pi (xi ) − Di (Ti1 x1 + · · · + Tin xn ).

P: production function, Di damage cost function, Tij : transport

matrix coefficients
Motivation Games in strategic form Games in extensive form

Some concrete games (ctd.)

The Hotelling bi-matrix game depends on two parameters:
integer n ≥ 1 and w ∈ ]0, 1]. Consider the n + 1 points of
H := {0, 1, . . . , n} on the real line, to be referred to as vertices.
0 1 2 3 4 5 ··· n

Two players simultaneously and independently choose a

vertex. If player 1 (2) chooses vertex x1 ( x2 ), then:
Case w = 1: the payoff fi (x1 , x2 ) of player i is the number
of vertices that is the closest to his choice xi ; however, a
shared vertex, i.e. one that has equal distance to both
players, contributes only 1/2.
General case: 0 < w ≤ 1: exactly the same vertices as in
the above for w = 1 contribute. Take such a vertex. If it is
at distance d to xi , then it contributes w d if it is not a
shared vertex, and otherwise it contributes w d /2.
Motivation Games in strategic form Games in extensive form

Some concrete games (ctd.)

Example n = 7 and w = 1.

Action profile ( 5,2 ) :

Payoffs:
1+1+1+1 = 4
1+1+1+1 = 4

Action profile ( 0,3 ) :

Payoffs
1+1=2
1+1+1+1+1+1 = 6
Motivation Games in strategic form Games in extensive form

Some concrete games (ctd.)

Example n = 7 and w = 1.

Action profile ( 2,6 ) :

Payoffs:
1 + 1 + 1 + 1 + 12 = 4 12
1 1
2 + 1 + 1 + 1 = 32

Action profile ( 3,3 ) :

Payoffs:
1 1 1 1 1 1 1 1
2 + 2 + 2 + 2 + 2 + 2 + 2 + 2 =4
1 1 1 1 1 1 1 1
2 + 2 + 2 + 2 + 2 + 2 + 2 + 2 =4
Motivation Games in strategic form Games in extensive form

Some concrete games (ctd.)

Example n = 5 and w = 1/4:

Action profile ( 1,3 ) :

Payoffs:
1 1 3
4 + 1 + 8 = 18
1 1 1 7
8 + 1 + 4 + 16 = 1 16

Action profile ( 1,4 ) :

Payoffs:
1 1 1
4 + 1 + 4 = 12
1 1 1
4 + 1 + 4 = 12
Motivation Games in strategic form Games in extensive form

Normalisation

Many games which are not defined as a game in strategic form

can be represented in a natural way by normalisation as a
game in strategic form.

For example, chess and tic-tac-toe: n = 2, Xi is set of

completely elaborated plans of playing of i,

fi (x1 , x2 ) ∈ {−1, 0, 1}.

Motivation Games in strategic form Games in extensive form

Fundamental notions

(z)
Conditional payoff function fi of player i: fi as a function
of xi for fixed strategy profile z of the opponents.
Best reply correspondence Ri of player i: assigns to each
strategy profile z of the opponents of player i the set of
(z)
maximisers Ri (z) of fi .
(Strictly) dominant strategy of a player i: (the) best
strategy of player i independently of strategies of the other
players.
Strongly (or strictly) dominated strategy of a player: a
strategy of a player for which there exists another strategy
that independently of the strategies of the other players
always gives a higher payoff.
Motivation Games in strategic form Games in extensive form

Solution concepts

Strictly dominant equilibrium : strategy profile where each

player has a strictly dominant strategy.
Procedure of iterative (simultaneous) elimination of strongly
dominated strategies
Strategy profile that survives this procedure .
If there is a unique strategy profile that survives the above
procedure this strategy profile is called the iteratively not
strongly dominated equilibrium .
Nash equilibrium : strategy profile such that no player
wants to change his strategy in that profile.
Motivation Games in strategic form Games in extensive form

Solution concepts (ctd.)

Theorem
1 Each strictly dominant equilibrium is an iteratively not
strongly dominated equilibrium.
And if the game is finite:
1 An iteratively not strongly dominated equilibrium is a
unique nash equilibrium.
2 Each nash equilibrium is an iteratively not strongly
dominated strategy profile. (So each nash equilibrium
survives the procedure.)

Proof.
1. Already in first steps of procedure all strategies are removed
with the exception of strictly dominant ones.
2, 3. One verifies that in each step of the procedure the set of
nash equilibria remains the same. (See the text book.)
Motivation Games in strategic form Games in extensive form

Nash equilibria

A strategy profile e = (e1 , . . . , en ) is a nash equilibrium if and

only if for each player i one has

ei ∈ Ri (e1 , . . . , ei−1 , ei+1 , . . . , en ).

Sometimes (in economics even ’often’) can be determined by

∂fi
= 0 (i = 1, . . . , n)
∂xi
Motivation Games in strategic form Games in extensive form

Example

Question: determine (if any), the strictly dominant equilibrium,

the iteratively not strongly dominated equilibrium (if any) and
the nash equilibria of the game
Example
 
2; 4 1; 4 4; 3 3; 0
 1; 1 1; 2 5; 2 6; 1 
 .
 1; 2 0; 5 3; 4 7; 3 
0; 6 0; 4 3; 4 1; 5

Answer:
Motivation Games in strategic form Games in extensive form

Example

Question: determine (if any), the strictly dominant equilibrium,

the iteratively not strongly dominated equilibrium and the nash
equilibria of the game
Example
 
6; 1 3; 1 1; 5
 2; 4 4; 2 2; 3 
5; 1 6; 1 5; 2
Answer:
Motivation Games in strategic form Games in extensive form

Example

Question: consider the Hotelling bi-matrix game in the case

n = 2 and w = 1/2. Determine the nash equilibria of this game
(by representing it as a 3 × 3-bi-matrix game with at the first
row strategy 0 for player 1, at the second row strategy 1 for
player 1, etc.)

Answer:
Motivation Games in strategic form Games in extensive form

Mixed strategies

Some games do not have a nash equilibrium.

Mixed strategy of player i: probability density over his

strategy set Xi .
With mixed strategies, payoffs have the interpretation of
expected payoffs.
Nash equilibrium in mixed strategies. Remark: each nash
equilibrium is a nash equilibrium in mixed strategies. (See
text book for formal proof.)
Motivation Games in strategic form Games in extensive form

Bi-matrix-game with mixed strategies

Consider a 2 × 2 bi-matrix-game

(A; B)

Strategies: (p, 1 − p) for player 1 and (q, 1 − q) for player B.

Expected payoffs:
 
q
f 1 (p, q) = (p, 1 − p) ∗ A ∗ ,
1−q
 
q
f 2 (p, q) = (p, 1 − p) ∗ B ∗ .
1−q
Motivation Games in strategic form Games in extensive form

Example

Example
Determine the nash equilibria in mixed strategies for
 
0; 0 1; −1
.
2; −2 −1; 1

Answer:
Motivation Games in strategic form Games in extensive form

Example

Example
Determine
 the nash
 equilibria in mixed strategies for
−1; 1 1; −1
.
1; −1 −1; 1

Answer:
Motivation Games in strategic form Games in extensive form

Other fundamental notions

If x = (x1 , . . . , xn ) and y = (y1 , . . . , yn ) are strategy profiles,
then one says:
z is an unanimous pareto-improvement of x if
fi (y) > fi (x) (i ∈ N);
y is a pareto-improvement of x if fi (y) ≥ fi (x) (i ∈ N) with
at least one of these inequalities strict.
A strategy profile x is called
(strongly) pareto-efficient if there does not exist a
pareto-improvement of x.
weakly pareto-efficient if there does not exist an
unanimous pareto-improvement of x.
(strongly) pareto-inefficient if it is not pareto efficient.
(weakly) pareto-inefficient if it is not weakly pareto
efficient.
Motivation Games in strategic form Games in extensive form

Other fundamental notions (cont.)

Fully cooperative strategy profile: a strategy profile that

maximizes the total payoff.
Prisoners’ dilemma : a game in strategic form where there
is a strictly dominant weakly pareto-inefficient nash
equilibrium.
Motivation Games in strategic form Games in extensive form

Existence of nash equilibria

Conditional payoff function of player i: fi as a function of xi ,

given strategies of the other players.
Theorem
(Nikaido-Isoda.) Each game in strategic form where
1 each strategy set is a convex compact subset of some Rn ,
2 each payoff function is continuous,
3 each conditional payoff function is quasi-concave,
has a nash equilibrium.

Proof.
This is a deep theoretical result. A proof can be based on
Brouwer’s fixed point theorem. See text book for the proof of a
simpler case (Theorem 7.2., i.e. the next theorem).
Motivation Games in strategic form Games in extensive form

Theorem of Nash

Theorem
Each bi-matrix-game has a nash equilibrium in mixed
strategies.

Proof.
Apply the Nikaido-Isoda result.
Motivation Games in strategic form Games in extensive form

Antagonistic game

Consider an antagonistic game : two players and f1 + f2 = 0.

(Cfr. with Exercise 7.7 in the text book.)
Theorem
If (a1 , a2 ) and (b1 , b2 ) are nash equilibria, then
f1 (a1 , a2 ) = f1 (b1 , b2 ) and f2 (a1 , a2 ) = f2 (b1 , b2 ).

Proof.
f1 (a1 , a2 ) ≥ f1 (b1 , a2 ) = −f2 (b1 , a2 ) ≥ −f2 (b1 , b2 ) = f1 (b1 , b2 ).
In the same way f1 (b1 , b2 ) ≥ f1 (a1 , a2 ). Therefore
f1 (a1 , a2 ) = f1 (b1 , b2 ) and thus f2 (a1 , a2 ) = f2 (b1 , b2 ).
Motivation Games in strategic form Games in extensive form

Little test

Are the following statements about games in strategic form true

or false?
a. If each player has a dominant strategy, then there exists a
unique Nash equilibrium.
b. A player has at most one strictly dominant strategy.
c. The 2 × 2-bi-matrix-game:
 
4; 0 2; −2
0; 1 1; 0

has a strictly dominant equilibrium.

Motivation Games in strategic form Games in extensive form

Little test (ctd.)

d. The 3 × 2-bi-matrix-game:
 
4; 0 2; −2
 0; 1 1; 0 
2; −1 3; −2
does not have a Nash equilibrium in mixed strategies.
e. If each strategy profile is a Nash equilibrium, then each
payoff function is constant.
f. Each fully cooperative strategy profile is pareto efficient.
g. In a zero-sum game each strategy profile is pareto efficient.
h. It is possible that a pure strategy is not strongly dominated
by a pure strategy, but is by a mixed strategy.
i. It is possible that a best-reply-correspondence of a player
is empty-valued, i.e. that given strategies of the other
players there does not exist a best reply of that player. T
Motivation Games in strategic form Games in extensive form

Appetizer

t-t-t chess 8 × 8 checkers hex

value draw not known draw 1
opt. strat. known not known known not known
Value : outcome of the game in the case of two rational
intelligent players.
Optimal strategy for a player: a strategy that guarantees
this player at least the value.
Motivation Games in strategic form Games in extensive form

Hex

1 Invented independently by Piet Hein and John Nash.

2 http://www.lutanho.net/play/hex.html.
3 Hex can not end in a draw. (‘Equivalent’ with Brouwer’s
fixed point theorem in two dimensions.)
4 If You can give a winning strategy for hex, then You solved
a ‘1-million-dollar problem’.
Motivation Games in strategic form Games in extensive form

Games in extensive form

Our setting is always non-cooperative with complete information

(and for the moment) perfect information and no chance moves.
Game tree:
Nodes (or histories): end nodes, decision nodes, unique
initial node.
Directed branches.
Payoffs at end nodes.
Each non-initial node has exactly one predecessor.
No path in tree connects a node with itself.
Game is finite (i.e. a finite number of branches and nodes).
Actual moves can be denoted by arrows.
Motivation Games in strategic form Games in extensive form

Perfect information (ctd.)

Theoretically:
Imperfect information can be dealt with by using
information sets. The information sets form a partition of
the decision nodes. (Example: Figure 7.10.)
Perfect information: all information sets are singletons.
Solution concept: Nash equilibrium.
Games in strategic form are games with imperfect
information.
Motivation Games in strategic form Games in extensive form

Normalisation

Strategy : specification at each decision node how to move.

(This may be much more than a completely elaborated plan of
play.)

Normalisation : make out (in natural way) of game in extensive

form a game in strategic form.

So normalisation destroys the perfect information.

All terminology and results for games in strategic form now also
applies to games in extensive forms.
Motivation Games in strategic form Games in extensive form

Solving from the end to the beginning

Example
Consider the following game between two (rational and
intelligent) players. There is a pillow with 21 matches. They
alternately remove 1, 3 or 4 matches from it. (Player 1 begins.)
The player who makes the last move wins. Who will win?

Answer:
Motivation Games in strategic form Games in extensive form

Procedure of backward induction (explained at the blackboard)

leads to a non-empty set of backward induction strategy
profiles.
Theorem
(Kuhn.) Each backward induction strategy profile of a finite
game in extensive form with perfect information is a nash
equilibrium.

Proof.
See text book.

But (as we shall see) a nash equilibrium is not necessarily a

backward induction strategy profile.
Motivation Games in strategic form Games in extensive form

Hex-game revisited

As the game cannot end in a draw, the above theory

guarantees that player 1 or player 2 has a winning strategy.
Here is a proof that player 1 has such a strategy by a
strategy-stealing argument:
Motivation Games in strategic form Games in extensive form

Hex-game revisited (ctd.)

suppose that the second player has a winning strategy, which

we will call S. We can convert S into a winning strategy for the
first player. The first player should make his first move at
random; thereafter he should pretend to be the second player,
‘stealing’ the second player’s strategy S, and follow strategy S,
which by hypothesis will result in a victory for him. If strategy S
calls for him to move in the hexagon that he chose at random
for his first move, he should choose at random again. This will
not interfere with the execution of S, and this strategy is always
at least as good as S since having an extra marked square on
the board is never a disadvantage in hex.
Motivation Games in strategic form Games in extensive form

Subgame perfection

Subgame : game starts at a decision node.

Subgame perfect nash equilibrium : a nash equilibrium that
remains for each subgame a nash equilibrium.
Theorem
For every finite extensive form game with perfect information
the set of backward induction strategy profiles coincides with
the set of subgame perfect nash equilibria.

Proof.
See text book.
Motivation Games in strategic form Games in extensive form

Games in extensive form: extensions

Three extensions:
Imperfect information.
Incomplete information: the solution concept here is that of
Bayesian equilibrium (7.2.3.). [Next part of course.]
Randomization.
Motivation Games in strategic form Games in extensive form

Imperfect information
Imperfect information.
Can be dealt with by using information sets. The
information sets form a partition of the decision nodes.
(Example: Figure 7.10.)
Perfect information: all information sets are singletons.
Strategy: specification at each information set how to
move.
The procedure of backward induction cannot be applied
anymore, but the notion of subgame perfect Nash
equilibria still makes sense (when ’subgame’ is properly
defined). [Next part of course.]
Subgame: not all decision nodes define anymore a
subgame. (Example: Figure 7.20.) [Next part of course.]
Nash equilibria need not always exist. (Example: Figure
7.23.) [Next part of course.]
Motivation Games in strategic form Games in extensive form

Randomization

Three types of strategies: pure, mixed and behavioural

strategies.
Motivation Games in strategic form Games in extensive form

Randomization

[Next part of the course.]

A pure strategy of player i is a book with instructions where
there is for each decision node for i a page with the
content which move to make at that node. So the set of all
pure strategies of player i is a library of such books.
A mixed strategy of player i is a probability density on his
library. Playing a mixed strategy now comes down to
choosing a book from this library by using a chance device
with the prescribed probability density.
Motivation Games in strategic form Games in extensive form

Randomization (ctd.)

A behavioural strategy, is like a pure strategy also a book,

but of a different kind. Each page in the book still refers to
a decision node, but now the content is not which move to
make but a probability density between the possible
moves.
For many games (for instance those with perfect recall) it
makes no difference whatever if players employ mixed or
behavioural strategies.
Motivation Games in strategic form Games in extensive form

Nash

John Nash (1928 – 2015).

Mathematician. (Economist ?)
Nobel price for economics in 1994, together with Harsanyi
and Selten.
Abel Price for mathematics in 2015. Just after having
received it he was killed in a car crash.
Got this price for his PhD dissertation (27 pages) in 1950.

http://topdocumentaryfilms.com/a-brilliant-madne
.