Bayesian Games

Abdul Quadir
XLRI

2 January, 2020
Introduction

I Game with incomplete information

I Bayes-Nash equilibrium
I Screening and signaling
Reading: Dixit and Skeath, Chapter 8.
Incomplete Information

Strategic situations involve uncertainty about the following

elements of the game:
I Uncertainty about others’ preferences
I Uncertainty about others’ available strategies
I Uncertainty about others’ information
I There are incentives about learning these uncertainties.
Examples
I Bargaining (how much is opponent willing to pay?)
I Auctions (how much do others value the object?)
I Market competition (what costs do my competitors face?)
I Social learning (What can I infer from others’ choices?)
Incomplete Information

Strategic situations involve uncertainty about the following

elements of the game:
I Uncertainty about others’ preferences
I Uncertainty about others’ available strategies
I Uncertainty about others’ information
I There are incentives about learning these uncertainties.
Examples
I Bargaining (how much is opponent willing to pay?)
I Auctions (how much do others value the object?)
I Market competition (what costs do my competitors face?)
I Social learning (What can I infer from others’ choices?)
Introduction
I In many strategic form game, we have assumed that
everything about the game is known.
I But it could be the case that the games might be affected by
some external factor.
I These external factor will be known with varying probabilities.
I Let us consider an example to understand this:
I Two agents are deciding to meet.
I Each agent observes the weather in his city but does not know
the the weather of other agent’s city.
I An agents has set of actions based on the weather in his
respective city.
I The utility depends on the weather in both the cities and the
actions chosen by both the agents.
I Weather in each city is a signal privately observed by the
player.
Introduction

I The uncertain part in this example is weather.

I The player uses common prior to evaluate uncertainty using
expected utility.
I There is a probability distribution about weather in both the
cities.
I Note that since an agent can observe weather in his own city,
he can use Bayes rule to update the conditional probabilities.
I The strategies and payoffs of players are complicated objects
because
I it depends on the signals that players receive.
I there is uncertainty about the signals of other players.
I Harasanyi first formalized this sort of games.
Example

I Player 1 and Player 2 would like to meet each other either at

the mall or library.
I There are various preferences over two options.
I It is given in the following matrix:
M L
M (2,1) (0,0)
L (0,0) (1,2)
I There are two pure strategy equilibria and one mixed strategy
equilibrium.
I Now, suppose Player 1 is unsure whether Player 2 wants to
meet or avoid Player 1.
Example

I Player 1 and Player 2 would like to meet each other either at

the mall or library.
I There are various preferences over two options.
I It is given in the following matrix:
M L
M (2,1) (0,0)
L (0,0) (1,2)
I There are two pure strategy equilibria and one mixed strategy
equilibrium.
I Now, suppose Player 1 is unsure whether Player 2 wants to
meet or avoid Player 1.
Example

I To model this, we assume Player 2 has one of two possible

types.
I One type wants to meet, the other wants to avoid.
Suppose the two types are equally likely, two possible payoff
matrices

1/2 M L 1/2 M L
M (2,1) (0,0) M (2,0) (0,2)
L (0,0) (1,2) L (0,2) (1,0)

Player 2 knows which game is played but Player 1 does not know.
What are strategies?
Example

I To model this, we assume Player 2 has one of two possible

types.
I One type wants to meet, the other wants to avoid.
Suppose the two types are equally likely, two possible payoff
matrices

1/2 M L 1/2 M L
M (2,1) (0,0) M (2,0) (0,2)
L (0,0) (1,2) L (0,2) (1,0)

Player 2 knows which game is played but Player 1 does not know.
What are strategies?
Example

I To model this, we assume Player 2 has one of two possible

types.
I One type wants to meet, the other wants to avoid.
Suppose the two types are equally likely, two possible payoff
matrices

1/2 M L 1/2 M L
M (2,1) (0,0) M (2,0) (0,2)
L (0,0) (1,2) L (0,2) (1,0)

Player 2 knows which game is played but Player 1 does not know.
What are strategies?
Example

I Idea: Use Nash equilibrium in an expanded form game.

I Think of each type of player 2 as a separate player.
I Equivalently, form conjecture about behavior in each possible
state, and maximize expected utility given the conjecture.
I Consider the profile (M, (M, L))
I Player 1 goes to the mall
I Player 2 goes to the mall in state 1 and the library in state 2.
I Clearly a best response for player 2.
Example

I Idea: Use Nash equilibrium in an expanded form game.

I Think of each type of player 2 as a separate player.
I Equivalently, form conjecture about behavior in each possible
state, and maximize expected utility given the conjecture.
I Consider the profile (M, (M, L))
I Player 1 goes to the mall
I Player 2 goes to the mall in state 1 and the library in state 2.
I Clearly a best response for player 2.
Example

I Idea: Use Nash equilibrium in an expanded form game.

I Think of each type of player 2 as a separate player.
I Equivalently, form conjecture about behavior in each possible
state, and maximize expected utility given the conjecture.
I Consider the profile (M, (M, L))
I Player 1 goes to the mall
I Player 2 goes to the mall in state 1 and the library in state 2.
I Clearly a best response for player 2.
Example

I Idea: Use Nash equilibrium in an expanded form game.

I Think of each type of player 2 as a separate player.
I Equivalently, form conjecture about behavior in each possible
state, and maximize expected utility given the conjecture.
I Consider the profile (M, (M, L))
I Player 1 goes to the mall
I Player 2 goes to the mall in state 1 and the library in state 2.
I Clearly a best response for player 2.
Example

I Let us now check for Player 1.

I For Player 1, both the state is equally likely. Thus,
1 1
E [u1 (M, (M, L))] = ·2+ ·0=1
2 2

I Similarly, playing L will yiled the following expected utility to

Player 1
1 1 1
E [u1 (L, (M, L))] = ·0+ ·1= .
2 2 2

I Hence, the profile (M, (M, L)) is a (Bayes) Nash Equilibrium

Example

I Let us now check for Player 1.

I For Player 1, both the state is equally likely. Thus,
1 1
E [u1 (M, (M, L))] = ·2+ ·0=1
2 2

I Similarly, playing L will yiled the following expected utility to

Player 1
1 1 1
E [u1 (L, (M, L))] = ·0+ ·1= .
2 2 2

I Hence, the profile (M, (M, L)) is a (Bayes) Nash Equilibrium

Example

I Let us now check for Player 1.

I For Player 1, both the state is equally likely. Thus,
1 1
E [u1 (M, (M, L))] = ·2+ ·0=1
2 2

I Similarly, playing L will yiled the following expected utility to

Player 1
1 1 1
E [u1 (L, (M, L))] = ·0+ ·1= .
2 2 2

I Hence, the profile (M, (M, L)) is a (Bayes) Nash Equilibrium

Example

I Note meeting at the library, player 2’s preferred outcome, is

no longer part of an equilibrium.
I Consider the profile (L, (L, M)).
I Again, clearly a best response for player 2
I For Player 1, both the state is equally likely. Thus,
1 1 1
E [u1 (L, (L, M))] = ·1+ ·0=
2 2 2
I However, playing M will yield
1 1
E [u1 (M, (L, M))] = ·0+ ·2=1
2 2
I Thus, player 1 can benefit by deviating from playing L to M,
I Hence, (L, (L, M)) is not a Bayes-Nash equilibrium.
Example

I Note meeting at the library, player 2’s preferred outcome, is

no longer part of an equilibrium.
I Consider the profile (L, (L, M)).
I Again, clearly a best response for player 2
I For Player 1, both the state is equally likely. Thus,
1 1 1
E [u1 (L, (L, M))] = ·1+ ·0=
2 2 2
I However, playing M will yield
1 1
E [u1 (M, (L, M))] = ·0+ ·2=1
2 2
I Thus, player 1 can benefit by deviating from playing L to M,
I Hence, (L, (L, M)) is not a Bayes-Nash equilibrium.
Bayesian Game

Definition
A Bayesian game consists of
I A set of players N
I A set of actions (pure strategies) Si for each player i.
I A set of types Ti for each player i
I A payoff function ui (s, t) for each player i
I A (joint) probability distribution p(t1 , t2 , . . . , tn ) over types

Note payoffs depend on vector of actions and vector of types

Bayesian Game

I We maintain the assumption that the probability distribution

p is common knowledge.
I In other words, players agree on the prior probability of
different type vectors.
I This is a very strong assumption but very convenient.
I This leads to avoid having to deal with hierarchies of beliefs.

Definition
A pure strategy for player i is a map si : Ti → Si prescribing an
action for each type of player i.
Bayesian Equilibrium

Bayesian equilibrium is a collection of strategies (one for each type

of each player) such that each type best responds given her beliefs
about other players’ types and strategies.

This is also known as Bayesian Nash or Bayes Nash equilibrium

Example: Bank Runs

I Consider two Players 1 and 2 who have a deposit of

100million rupees each in a bank.
I If the bank manager is a good investor you will each get 150
million rupees at the end of the year. If not they will loose
their money.
I Player 1 can try to withdraw his money now but the bank has
only 100milion rupees cash.
I If only one tries to withdraw he gets 100 million rupees.
I If both try to withdraw they each get 50million rupees.
I Player 1 believes that the manager is good with probability q
I Player 2 knows whether manager is good or bad.
I Player 1 and Player 2 simultaneously decide whether to
withdraw or not.
Example: Bank Runs

I The payoffs can be summarized as follows

1/2 W N 1/2 W N
W (50,50) (100,0) W (50,50) (100,0)
N (0,100) (150,150) N (0,100) (0,0)
Good q Bad (1 − q)
I Two types of Bayesian equilibria
I Separating Equilibria: Each type plays a different strategy.
I Pooling equilibria: Each type plays the same strategy.
I How would Player 1 play if he was Player 2 who knew the
banker was bad?
I Player 2 always withdraw in bad state.
Example: Bank Runs

I The payoffs can be summarized as follows

1/2 W N 1/2 W N
W (50,50) (100,0) W (50,50) (100,0)
N (0,100) (150,150) N (0,100) (0,0)
Good q Bad (1 − q)
I Two types of Bayesian equilibria
I Separating Equilibria: Each type plays a different strategy.
I Pooling equilibria: Each type plays the same strategy.
I How would Player 1 play if he was Player 2 who knew the
banker was bad?
I Player 2 always withdraw in bad state.
Example: Bank Runs

I The payoffs can be summarized as follows

1/2 W N 1/2 W N
W (50,50) (100,0) W (50,50) (100,0)
N (0,100) (150,150) N (0,100) (0,0)
Good q Bad (1 − q)
I Two types of Bayesian equilibria
I Separating Equilibria: Each type plays a different strategy.
I Pooling equilibria: Each type plays the same strategy.
I How would Player 1 play if he was Player 2 who knew the
banker was bad?
I Player 2 always withdraw in bad state.
Separating Equilibria
I One possibility is withdraw in good state and Not withdraw in
bad state (Good: W, Bad: N)
I Not possible because W is dominant strategy for Bad.
I Another possibility is (Good: N, Bad: W)
I Player 1’s expected payoffs:

W :q × 100 + (1 − q) × 50
N :q × 150 + (1 − q) × 0

I Two possibilities:
I Player 1 chooses W if q < 12 . But the Player 2 of Good type
must play W,which contradicts our hypothesis that he plays N.
I Player 1 plays N if q ≥ 21 . The best response of player 2 of
Good type is N, which is the same as our hypothesis.
I No separating equilibrium if q < 21 .
I If q ≥ 12 , then Player 1: N, Player 2 (Good: N, Bad: W).
Separating Equilibria
I One possibility is withdraw in good state and Not withdraw in
bad state (Good: W, Bad: N)
I Not possible because W is dominant strategy for Bad.
I Another possibility is (Good: N, Bad: W)
I Player 1’s expected payoffs:

W :q × 100 + (1 − q) × 50
N :q × 150 + (1 − q) × 0

I Two possibilities:
I Player 1 chooses W if q < 12 . But the Player 2 of Good type
must play W,which contradicts our hypothesis that he plays N.
I Player 1 plays N if q ≥ 21 . The best response of player 2 of
Good type is N, which is the same as our hypothesis.
I No separating equilibrium if q < 21 .
I If q ≥ 12 , then Player 1: N, Player 2 (Good: N, Bad: W).
Separating Equilibria
I One possibility is withdraw in good state and Not withdraw in
bad state (Good: W, Bad: N)
I Not possible because W is dominant strategy for Bad.
I Another possibility is (Good: N, Bad: W)
I Player 1’s expected payoffs:

W :q × 100 + (1 − q) × 50
N :q × 150 + (1 − q) × 0

I Two possibilities:
I Player 1 chooses W if q < 21 . But the Player 2 of Good type
must play W,which contradicts our hypothesis that he plays N.
I Player 1 plays N if q ≥ 12 . The best response of player 2 of
Good type is N, which is the same as our hypothesis.
I No separating equilibrium if q < 12 .
I If q ≥ 12 , then Player 1: N, Player 2 (Good: N, Bad: W).
Separating Equilibria
I One possibility is withdraw in good state and Not withdraw in
bad state (Good: W, Bad: N)
I Not possible because W is dominant strategy for Bad.
I Another possibility is (Good: N, Bad: W)
I Player 1’s expected payoffs:

W :q × 100 + (1 − q) × 50
N :q × 150 + (1 − q) × 0

I Two possibilities:
I Player 1 chooses W if q < 21 . But the Player 2 of Good type
must play W,which contradicts our hypothesis that he plays N.
I Player 1 plays N if q ≥ 12 . The best response of player 2 of
Good type is N, which is the same as our hypothesis.
I No separating equilibrium if q < 12 .
I If q ≥ 12 , then Player 1: N, Player 2 (Good: N, Bad: W).
Pooling Equilibria

I First possibility is (Good: N, Bad: N).

I Not possible because W is dominant strategy for Bad.
I Second possibility is (Good: W, Bad: W).
I Player 1’s expected payoffs:

W :q × 50 + (1 − q) × 50
N :q × 0 + (1 − q) × 0

I Thus, W is the best response for Player 1 for any q.

I Pooling equilibrium: Player 1 W , Player 2 (Good: W, Bad:
W)
1
I For q < 2 the only equilibrium is bank run.
Pooling Equilibria

I First possibility is (Good: N, Bad: N).

I Not possible because W is dominant strategy for Bad.
I Second possibility is (Good: W, Bad: W).
I Player 1’s expected payoffs:

W :q × 50 + (1 − q) × 50
N :q × 0 + (1 − q) × 0

I Thus, W is the best response for Player 1 for any q.

I Pooling equilibrium: Player 1 W , Player 2 (Good: W, Bad:
W)
1
I For q < 2 the only equilibrium is bank run.
Pooling Equilibria

I First possibility is (Good: N, Bad: N).

I Not possible because W is dominant strategy for Bad.
I Second possibility is (Good: W, Bad: W).
I Player 1’s expected payoffs:

W :q × 50 + (1 − q) × 50
N :q × 0 + (1 − q) × 0

I Thus, W is the best response for Player 1 for any q.

I Pooling equilibrium: Player 1 W , Player 2 (Good: W, Bad:
W)
1
I For q < 2 the only equilibrium is bank run.
Pooling Equilibria

I First possibility is (Good: N, Bad: N).

I Not possible because W is dominant strategy for Bad.
I Second possibility is (Good: W, Bad: W).
I Player 1’s expected payoffs:

W :q × 50 + (1 − q) × 50
N :q × 0 + (1 − q) × 0

I Thus, W is the best response for Player 1 for any q.

I Pooling equilibrium: Player 1 W , Player 2 (Good: W, Bad:
W)
1
I For q < 2 the only equilibrium is bank run.
Example: Quantity Competition with Incomplete
Information
I Two firms produce an identical good at constant marginal cost
I Inverse demand is P(Q) = α − Q, where Q = q1 + q2 is the
total quantity.
I Firm 1 has marginal cost c that is common knowledge.
I Firm 2’s marginal cost is private information: cl with
probability θ and ch with probability 1 − θ.
I Game has two players and two states (l and h), actions
qi ∈ [0, ∞).
I Payoffs for the two players are

u1 (q1 , q2 , t) = qi (P(q1 + q2 ) − c)
u2 (q1 , q2 , t) = q2 (P(q1 + q2 ) − ct )

where t ∈ {l, h} is firm’s 2type.

Example: Quantity Competition With Incomplete
Information
I we can think of strategy profile a triple (q1∗ , ql∗ , qh∗ ).
I We can get the three best response functionas
B1 (ql , qh ) = arg max q1 (θP(q1 + ql ) + (1 − θ)(P(q1 + qh ) − c)
q1 ≥0

Bl (q1 ) = arg max ql (P(q1 + ql ) − cl )

ql ≥0

Bh (q1 ) = arg max qh (P(q1 + qh ) − ch )

qh ≥0

I Bayes Nash equilibria are triples (q1∗ , ql∗ , qh∗ ) such that
B1 (ql∗ , qh∗ ) = q1∗ , Bl (q1∗ ) = ql∗ , Bh (q1∗ ) = qh∗ .

π1 = q1 [θ(α − (q1 + ql ) + (1 − θ)(α − (q1 + qh )) − c)

πl = ql (α − (q1 + ql ) − cl )
πh = qh (α − (q1 + qh ) − ch )
Example: Quantity Competition With Incomplete
Information
I we can think of strategy profile a triple (q1∗ , ql∗ , qh∗ ).
I We can get the three best response functionas
B1 (ql , qh ) = arg max q1 (θP(q1 + ql ) + (1 − θ)(P(q1 + qh ) − c)
q1 ≥0

Bl (q1 ) = arg max ql (P(q1 + ql ) − cl )

ql ≥0

Bh (q1 ) = arg max qh (P(q1 + qh ) − ch )

qh ≥0

I Bayes Nash equilibria are triples (q1∗ , ql∗ , qh∗ ) such that
B1 (ql∗ , qh∗ ) = q1∗ , Bl (q1∗ ) = ql∗ , Bh (q1∗ ) = qh∗ .

π1 = q1 [θ(α − (q1 + ql ) + (1 − θ)(α − (q1 + qh )) − c)

πl = ql (α − (q1 + ql ) − cl )
πh = qh (α − (q1 + qh ) − ch )
Example: Quantity Competition With Incomplete
Information
I we can think of strategy profile a triple (q1∗ , ql∗ , qh∗ ).
I We can get the three best response functionas
B1 (ql , qh ) = arg max q1 (θP(q1 + ql ) + (1 − θ)(P(q1 + qh ) − c)
q1 ≥0

Bl (q1 ) = arg max ql (P(q1 + ql ) − cl )

ql ≥0

Bh (q1 ) = arg max qh (P(q1 + qh ) − ch )

qh ≥0

I Bayes Nash equilibria are triples (q1∗ , ql∗ , qh∗ ) such that
B1 (ql∗ , qh∗ ) = q1∗ , Bl (q1∗ ) = ql∗ , Bh (q1∗ ) = qh∗ .

π1 = q1 [θ(α − (q1 + ql ) + (1 − θ)(α − (q1 + qh )) − c)

πl = ql (α − (q1 + ql ) − cl )
πh = qh (α − (q1 + qh ) − ch )
Example: Quantity Competition with Incomplete
Information
I Therefore, the three best response function are given as:
1
q1 (ql , qh ) = [θ(α − ql ) + (1 − θ)(α − qh ) − c]
2
1
ql (q1 ) = (α − q1 − cl )
2
1
qh (q1 ) = (α − q1 − ch )
2

I Therefore, Bayes Nash equilibrium is

1
q1∗ = (α − 2c + θcl + (1 − θ)ch )
3
1 1−θ
ql∗ = (α − 2cl + c) − (ch − cl )
3 6
1 θ
qh∗ = (α − 2ch + c) + (ch − cl )
3 6
I Note ql∗ > qh∗ , type with lower cost produces more.
Example: Quantity Competition with Incomplete
Information
I Therefore, the three best response function are given as:
1
q1 (ql , qh ) = [θ(α − ql ) + (1 − θ)(α − qh ) − c]
2
1
ql (q1 ) = (α − q1 − cl )
2
1
qh (q1 ) = (α − q1 − ch )
2

I Therefore, Bayes Nash equilibrium is

1
q1∗ = (α − 2c + θcl + (1 − θ)ch )
3
1 1−θ
ql∗ = (α − 2cl + c) − (ch − cl )
3 6
1 θ
qh∗ = (α − 2ch + c) + (ch − cl )
3 6
I Note ql∗ > qh∗ , type with lower cost produces more.
Example: Quantity Competition with Incomplete
Information

I In the game with complete information, the Nash equilibrium

involves players producing
1
qi = (α − 2ci + cj )
3
I With incomplete information, firm 2 produces more than this
when its cost is ch and less when its cost is cl .
I This is because firm 1 produces a moderated output.
I When firm 2 has cost ch , firm 1 produces less than it would if
it knew ch , so firm 2 gets to produce a bit more.
I When firm 2 has cost cl , firm 1 produces more than it would
if it knew cl , so firm 2 gets to produce a bit less.
Example: Quantity Competition with Incomplete
Information

I In the game with complete information, the Nash equilibrium

involves players producing
1
qi = (α − 2ci + cj )
3
I With incomplete information, firm 2 produces more than this
when its cost is ch and less when its cost is cl .
I This is because firm 1 produces a moderated output.
I When firm 2 has cost ch , firm 1 produces less than it would if
it knew ch , so firm 2 gets to produce a bit more.
I When firm 2 has cost cl , firm 1 produces more than it would
if it knew cl , so firm 2 gets to produce a bit less.
Example: Market for Used Cars

I Consider a used car market where a car is good with

probability q ∈ [0, 1] and bad with probability (1 − q).
I There is one buyer and one seller.
I The seller knows the types of car but buyer does not know.
I There is a price for every used car p.
I The probability q is common knowledge.
I The seller has to possible actions: SELL and NOT SELL.
I The buyer has two possible actions: BUY and NOT BUY.
I If the car is good, then the buyer enjoys a value of 6 and the
seller enjoys a value of 5.
I If the car is bad, the buyer enjoys a value of 4 and the seller
has zero value for it.
I Note that in both the cases it is “efficient” to trade the car.
Example: Market for Used Cars

I What is the Bayesian game?

I The nature informs the seller if the car is good or bad.
I If the car is good, then the following game will be played:
Sell Not Sell
Buy 6 − p, p 0, 5
Not Buy 0, 5 0, 5
I If the car is bad, then the following game will be played:
Sell Not Sell
Buy 4 − p, p 0, 0
Not Buy 0, 0 0, 0
I In the interim stage (just after the nature moves), the seller
will know which game will be played.
I The buyer will not know which game will be played.