DYNAMIC GAMES

GAMES OF IMPERFECT
INFORMATION
IMPERFECT INFORMATION
¢ In all previous dynamic games we analyzed,
every player observes what other players have
played before he moves. These games are named
games of perfect information
¢ We want to analyze now dynamic games in which
there is at least one player who does not observe
an action previously played by another player
¢ These games are named games of imperfect
information
A MOTIVANTING EXAMPLE:
ENTRY GAME WITH SIMULTANEOUS PRICE
DECISION

¢ Consider a canonical entry game in which after

player 1’s (the entrant) decision whether to enter
in a mkt, the incumbent and the entrant play
simultaneously.
¢ After the entry firms play a simplified Bertrand
game in which they can choose to play F or NF.
A MOTIVATING EXAMPLE
AN INCORRECT REPRESENTATION!
1

Out
In
2 (0,2)

F NF
1

F NF F NF

(-3, -1) (-2-1) (1,-2) (3,1)

INFORMATION SETS
¢ The previous representation neglects an
important element of the game
¢ Firm 1 cannot condition its price strategy to the
price chosen by firm 2 because the decision is
simultaneous!
¢ Firm 1 can play either H or L but an action that
varies depending on what price the other firm
chooses: for instance firm 1cannot play H if
firm 2 ha played H and L if firm 2 plays L.
¢ We need to specify correctly which information
every player has at the time she moves!
INFORMATION SETS
¢ If a player has the same information in two or
more different decision nodes, i.e. she cannot
distinguish in which node she is playing, then
these nodes belong to the same information
set.
¢ The notion of information set is fundamental in
the analysis of games, because a player can
choose which action to play in every information
set, not in every decision node.
¢ A strategy of a player is a specification of an
action available, at every information set.
¢ If two or more decision nodes belong to the same
information set we represent that “they are
connected” with a dotted line.
¢ A player cannot choose two different actions in
two nodes that belong to the same information
set.
A CORRECT REPRESENTATION
1

Out
In
2 (0,2)

F NF

1 1.2
1.1
F NF F NF

(-3, -1) (-2-1) (1,-2) (3,1)

The normal form of the previous game

F NF

OUT, NF 0,2 0,2

OUT, F 0,2 0,2

IN,F -3,-1 1,-2

IN,NF -2,-1 3,1

¢ The Nash equilibria in which player 1 plays Out
are sustained by a “threat” that is not credible!
¢ Notice in fact that “Fight” is a dominated
strategy for firm 1.
¢ Since “No Fight” is a dominant strategy for firm
1, then a rational firm 2 should play NF because
it is the only best response to the dominant
strategy NF for firm 1.
¢ However, if in case of entry both firms play NF,
why firm 2 should play Out at the beginning?
SUBGAME PERFECT NASH EQUILIBRIUM
¢ To analyse games of incomplete information we
need to introduce the concept of subgames.
¢ A subgame is a portion of a game that can be
logically analysed independently from the rest of
the game.
¢ A subgame (i) starts from a single decision node
and contains all the successors; (ii) it can never
break an information set.
A CORRECT REPRESENTATION
1

Subgame
Out
In
2 (0,2)

F NF

1 1.2
1.1
F NF F NF

(-3, -1) (-2-1) (1,-2) (3,1)

 1

1. Which is the set of strategies

T R
for each player?
2. Which are the subgames
of this game? 2.1 2.2

B NB NA
A

3.1 3.2 3.3

L R S D E NE E NE

0 2 2 3 3 5 2 3
-1 0 1 0 -1 0 1 0
13
 1

T R
How many subgames
in this game?
2.1 2.2
Is this a subgame?

NO!
B NB NA
A

L R L R L R L R

0 2 2 3 3 5 2 3
-1 0 1 0 -1 0 1 0
14
SUBGAME PERFECT NASH EQUILIBRIUM
Definition A strategy profile is a Subgame Perfect
Nash equilibrium (SPNE) of a game if it induces a
Nash equilibrium in every subgame.

¢ A game is also a subgame of itself.

¢ It follows that every SPNE is also a NE but the
converse is not true!
¢ In the motivating initial example the strategy
profile such that player 1 plays (IN, NF) and
player 2 plays (NF) is the unique SPNE (but the
game has other NE)
STACKELBERG GAME
¢ Two firms competing a la Cournot (competition
in quantities)
¢ Decisions occur sequentially. Firm 1 (the Leader
in the market) decides how much to produce and
then (after having observe what firm 1 has done),
firm 2 (the Follower) decides how much to
produce.
¢ Market demand Q=100-p constant marginal costs
and equal to 4 for each firm.
¢ Which are the strategies of the two firms?

¢ Profits are the same as in the standard Cournot

game?
¢ Suppose firm 1 has produced 𝑞! which is the best
response for 2?
#$%&
!
¢ 𝑞" = : this is firm 2’s reaction curve as in the
"
standard Cournot game.
¢ Firm 1 can anticipate what firm 2 will produces for
any quantity 𝑞! :
¢ Firm 1 maximizes
#$%&!
𝑚𝑎𝑥&! (100 − 𝑞! − )𝑞! − 4𝑞!
"

1. Solve the game and discuss the difference w.r.t a

standard Cournot game.

2. Are there other Nash equilibria in this game that are

different than the strategy profile that you found?
FIRST MOVER ADVANTAGE
¢ In the SPNE q1=48 q2=24, p=28
¢ Leader’s profits are higher than follower’s profits
and higher of the profits the leader would have
obtained in the simultaneous Cournot game.
Leader avails of the first mover advantage.

¢ In this game there are many Nash equilibria. For

instance there is a Nash equilibrium that
coincides with the Nash equilibrium of the
simultaneous Cournot game:
¢ firm 1 produces 32 and firm 2 produces 32
irrespective of the quantity produced by firm 1,
e.g. for all q1, q2=32.
¢ As usual this NE is supported by a “threat” that
is not credible.
¢ When firm 2 observes that firm 1 has produced
48 it is not a best response to produce 32, so the
treath of ”producing this quantity irrespective of
what the leader has done” is not credible.
APPLICATIONS
THE CASE OF SUPREME COURT ELECTION

¢ US Senate nominates judges of the Supreme

Court after President’s proposal.

¢ A candidate is proposed to Senate and in case

her/his name does not reach a simple majority of
consensus another candidature is proposed.

¢ You act as Mister President’s advisor

¢ For simplicity assume there are three senators
(Mr. A, B and C) and four outcomes: three
possible candidates and the outcome of
postponing the election after the next
presidential election.
¢ Senators’ preferences are known and represented
in the next page.
¢ The President has to announce to the Senate the
list of candidates and the order according to
which candidates will be screened and voted by
the Senate.
 Senators’ preferences

A B C
1 Kennedy Ginsberg None
2 None Kennedy Bork
3 Bork Bork Ginsberg
4 Ginsberg None Kennedy

The alternative “None” is equivalent to postpone the election

after next election.
¢ You have to advise Mr. President about the order
according to which candidates are listed.
¢ Suppose that the best candidate for the President is
Judge Bork. Cn you suggest an order such that Bork is
going to be elected?
¢ And in case Kennedy is the best candidate for the
President?
¢ One order to elect Bork is
— Bork, Ginsberg, Kennedy

¢ For Kennedy an order is

— Kennedy, Ginsberg, Bork

Remark: to make a winning candidate is sufficient

to put him first in the list!
NO! For istance the order Bork, Kennedy,
Ginsberg: Bork is not elected!
 APPLICATIONS
STRATEGIC ENTRY DETERRENCE
¢ Consider a monopolistic market in which only
firm A operates
¢ Firms B and C sequentially decide whether to
enter in this market or not.
¢ Market demand is equal to Q=100-2p

¢ Marginal cost ar McA=15, McB=12, McC=10

¢ Firm C is the most efficient firm.

¢ Suppose after B and C have taken their decision,

all firms that entered in the market compete a la
Bertrand
¢ Entry is costly: each firm should pay a sunk cost
equal to 200 to enter in the market (not A that is
already active in the mkt)
APPLICATIONS: TIES YOUR HANDS
MOST FAVOURED CONSUMER CLAUSE
¢ A Standard Clause allowing a buyer to obtain the
best possible price on goods or services from a
seller by requiring it to provide the buyer with
the lowest price among all buyers in that market.
¢ If the seller wants to offer a different buyer a
lower price, it must also first offer that price to
the buyer with the most favored customer clause
(MFC), also known as a most favored nation
clause.
¢ Why this clause can guarantee your competitors
that you will not cut your price in the future?
 BEST PRICE GUARANTEE
¢ Why this contract clause may affect competition
reducing competitors’ incentive to cut price?
¢ It represents a credible threat that you will enter
in a price war. You make credible your
announcement because your customers
guarantee that you will match any price
¢ Moreover it helps to ne informed about your
competitors’ prices!