Game Theory:

Normal Form Games

Guillem Roig

Universidad del Rosario

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Two Game Representations

I Extensive Form: extensive representation of a game will be convenient

to describe the rules of the game, when a player moves when, and the
information players have when they must take a decision.

I Normal Form: the normal form or strategic representation is more

convenient to obtain a prediction (equilibrium) and to study the set of
equilibria (existence, multiplicity, optimality, etc.)

Focus
In this chapter we analyze NORMAL FORM GAMES.

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In this chapter we will study.
I 2. Normal Form Games of Complete Information.
2.1 Notation and Representation.
2.2 Dominant Strategies.
2.3 Nash Equilibrium.
2.4 Interpretations of Nash Equilibrium.
2.5 Applications of Nash equilibrium.
2.6 The Mixed Extension.

2.6.1 Computation of Equilibria in Mixed Strategies.

2.6.2 Justification of Mixed Strategy Equilibrium.
2.6.3 Experiments on Mixed Strategies.

2.7 General Equilibrium Existence Theorem.

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2.1 Notation and Representation

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Notation of Normal Form Games
I A normal form game consists of an ordered triplet:

G = (I, (Si )i∈I , (ui )i∈I ).

I I is the finite set of players.

I Si is the non-empty set of actions or strategies.

The set of strategy profiles is represented by S = Sj .

Q
I
j∈N
I The game is finite if for each player i ∈ I the strategy set is finite, |Si | < ∞.

I A preference relation i is represented by a utility function associating each

vector of strategies s = (si )i∈I with the payoff ui (s) to player i ui : S → R.
I The vector of strategies generates an outcome of the game and the utility
for a player is what he or she enjoys from that outcome.
I The fact that the utility function ui is a function of the vector of strategies s,
and not solely of the strategy of player i is what makes this a game and not
a simple decision problem.

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Representation of Normal Form Games
I A finite normal form game with two players can be conveniently illustrated in a
table or matrix.

I Let I = {1, 2}.

I S1 = {T, B}, S2 = {L, R}.
I S = S1 × S2 .
I Let w1 = u1 (T, L), w2 = u2 (T, L), x1 = u1 (T, R), x2 = u2 (T, R),
y1 = u1 (B, L), y2 = u2 (B, L), z1 = u1 (B, R) and z2 = u2 (B, R).

I Matrix representation.

1/2 L R
T w1 , w2 x1 , x2
B y1 , y2 z1 , z2

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2.2 Dominant Strategies

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Dominant Strategies

I For some games, there exists an action that is optimal independent of

other players’ choice. Such an optimal action is called dominant action
(or dominant strategy)

I Games with a dominant strategy will be easy to analyze as it is

reasonable to assume that a dominant action will be played by rational
agents.

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Dominant Strategies
Notation
I Consider the game G = (I, (Si )i∈I , (ui )i∈I ).

I Let S−i = Sj be the set of strategies of the rest of the players but player i.
Q
j6=i

I A strategy is strictly dominant if it is “always” strictly optimal:

I A strategy s0i ∈ Si is strictly dominant strategy for player i if for each

s−i ∈ S−i and each si 6= s0i ,

ui (s0i , s−i ) > ui (si , s−i ).

I A strategy is dominant if it is optimal for some strategies and indifferent for

others:
I A strategy s0i ∈ Si is dominant strategy for player i if for each s−i ∈ S−i and
each si ∈ Si ,
ui (s0i , s−i ) ≥ ui (si , s−i ),
with strict inequality for some s−i ∈ S−i for each si 6= s0i .

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Dominant Strategies
Equilibrium

I A strategy profile s∗ is a dominant strategy equilibrium if for each player

i, s∗i is an optimal strategy independent of the other players’ choice.

I A strategy profile s∗ ∈ S is dominant strategy equilibrium if for each

i ∈ N, each s−i ∈ S−i , and each si ∈ Si ,

ui (s∗i , s−i ) ≥ ui (si , s−i ).

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Dominant Strategies
Equilibrium

I A Dominant strategy equilibrium is the strongest and the less

controversial equilibrium concept as it transforms a game (a multi-agent
problem) into several one-agent problems.

I It does not even require the game to be common knowledge; in

particular, to compute a dominant strategy a player does not even need
to know the other players’ payoff.

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1) Prisoner’s Dilemma
Environment
I Two suspects are arrested by the police. The police have insufficient evidence for
a conviction of a major crime (e.g. the use of a fire weapon in a robbery). Having
separated the prisoners, each of them is offered the same deal.

I If one testifies for the prosecution against the other (Defects) and the other
remains silent (Cooperates), the defector goes free and the silent accomplice
receives the full sentence with the aggravation of lying to the authority.
I If both remain silent (Cooperate), both prisoners are sentenced for a minor
charge.
I If each betrays the other (Defect), each receive full sentence.

I The game is simultaneous as each one is assured that the other would not know
the action taken by the other before the end of the investigation.

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1) Prisoner’s Dilemma
Representation
I Notation of the prisoners’ dilemma game:

I Set of players I = {1, 2}.

I Set of strategies S1 = S2 = {C, D}.
I Utilities associated to outcomes of the game.
I u1 (D, D) = u2 (D, D) = 1,
I u1 (C, C) = u2 (C, C) = 3,
I u1 (D, C) = u2 (C, D) = 4,
I u1 (C, D) = u2 (D, C) = 0.

I The matrix representation is:

1/2 C D
C 3, 3 0, 4
D 4, 0 1, 1

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1) Prisoner’s Dilemma
Equilibrium
I Because players do not know what the other player will do, they have to hold a
belief about the action of the other.

I To obtain the equilibrium of the game consider the following:

I Consider that suspect 1 believes that the other suspect will cooperate and
not confess the crime.
I If suspect 1 defects and incriminates suspect 2, suspect 1will be
released and will get a utility of 4.
I If he cooperates and does not incriminate suspect 2, suspect 1 will
gets a minor sentence giving a payoff of 3.
I Consider that suspect 1 believes that the other suspect will defect and
incriminate him.
I If suspect 1 defects and incriminates suspect 2, both obtain the full
sentence giving a payoff of 1.
I If suspect 1 cooperates and does not incriminate suspect 2, suspect 1
receives the full sentence plus an aggravation for lying to the
authority giving a payoff of 0.

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1) Prisoner’s Dilemma
Equilibrium

I Strategy D (Defect) strictly dominates strategy C (Cooperate).

I The solution of the game is: each player chooses his dominant strategy giving the
solution (D, D).

I Both prisoners incriminate each other resulting in the payoff (1, 1).

I The pair of strategies (D, D) is inefficient.

I The strategy of both players cooperating (C, C) is unstable, because each

individual player can deviate and gain a better payoff.

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2) Battle of Sexes
I Imagine a couple that agreed to meet this evening, but cannot recall if they will
be attending the ballet or a football match (they cannot communicate with each
other).

I The man would most of all like to go to the football game. The woman would
like to go to the ballet. But both would prefer to go to the same place rather than
different ones.

I I = {m, w}.
I Sm = Sw = {F, B}.
I um (F, F) = uw (B, B) = 3, um (B, B) = uw (F, F) = 1,
um (F, B) = uw (F, B) = um (B, F) = uw (B, F) = 0.
I The matrix representation :

m/w F B
F 3, 1 0, 0
B 0, 0 1, 3

I Question: Does the game have a dominant strategy?

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3) Second Price Auction
Environment
I An indivisible object is offered for sale.

I In the auction n bidders with valuation vi ≥ 0 for each i = 1, ..., n, are competing
for the object.
I Each player knows his own private value vi but not the the values that the other
bidders attach to the object.

Rules
I Bidders make bids b = (b1 , ..., bn ) simultaneously.

I The highest bidder wins the object and pays the second highest bid.

I If there are more than one highest bidders, then one is randomly selected as the
winner and pays his own bid.

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3) Second Price Auction

Strategies
I The set of strategies available for each bidder is the set of possible bids
Si = [0, ∞].

Payoffs
I The winner of the auction is bidder i for which

bi = max bj .
j∈I

I The payoff to bidder i, with a strategy vector b = (b1 , ..., bn ) is


0 if bi < maxj∈I bj ,
ui (b) =  vi −maxj6=i bj 
if bi = maxj∈I bj .
{k:bk =maxj∈I bj }


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3) Second Price Auction

Theorem
In a second price auctions, bidding one’s own value (bi = vi ) is a dominant
strategy. Then, bi = vi , for each i ∈ I is a dominant strategy equilibrium.

I Robust result: it holds even if bidders do not know:

I The number of bidders participating in the auction.
I Their private values.
I Utility functions.

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3) Second Price Auction

Simple proof of the theorem: in equilibrium bi = vi .

1) Consider a situation in which you win the auction, i.e., vi > maxj6=i bj .
Therefore, your payoffs in equilibrium are vi − maxj6=i bj > 0.

I Offering a larger bid b0i > vi is not a profitable deviation. You still
win the auction and obtain the same payoffs (remember that you
pay the second highest bid).
I Offering a lower bid b0i < vi is not a profitable deviation. Either it
gives you the same payoff, when you win the auction, i.e.,
b0i > maxj6=i bj . Or you obtain a payoff of 0 when you lose the
auction, when b0i < maxj6=i bj .

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3) Second Price Auction

Simple proof of the theorem: in equilibrium bi = vi .

2) Consider a situation in which you lose the auction, i.e., vi < maxj6=i bj .
Therefore, the payoffs in equilibrium are 0.

I Offering a larger bid b0i > vi is not a profitable deviation. You either
still lose the auction and obtain 0. Or if you win, which implies that
b0i > maxj6=i bj you obtain negative payoff vi − maxj6=i bj < 0.
I Offering a lower bid b0i < vi is not a profitable deviation. You still
lose the auction because b0i < maxj6=i bj , and obtain a payoff of 0.

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4) Location Game

I Consider the case of two coffee chains JV and SB. There are 7 possible
locations between U of Los Andes and U of Rosario on Avenida Jimenez
to locate their coffee.

I There are 100 clients uniformly distributed between any two locations,
making a total market of 600 clients.

1 2 3 4 5 6 7
U of Los Andes U of R
100 100 100 100 100 100

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4) Location Game

I The choice of location is simultaneous and consumers purchase their

coffee to the closest location.
I The objective of the coffee chains is to maximize the (expected) number
of customers.
I The matrix representation of the game:

Locating at position 2 strictly dominates locating at position 1.

Locating at position 6 strictly dominates locating at position 7.

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Dominant Strategies

Existence

I In many games of economic interest, there does not exist a dominant

strategy specifying an obvious choice.

I To obtain a prediction of the game, we will need to work with another

equilibrium concept.

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2.3 Nash Equilibrium

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Nash Equilibrium

I Consider the game of coordination: two players can decide in going

either up or down.
I If both players meet, they obtain a payoff of 1.
I If players do not meet, they obtain a payoff of 0.

1/2 U D
U 1, 1 0, 0
D 0, 0 1, 1

I Note: no player in this game has a dominant strategy.

I The concept of Nash Equilibrium allows to obtain predictions of the

outcome of the game when dominant strategies do not exist.

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Nash Equilibrium

I Players are in a strategic situation: each player’s optimal choice

depends on the other players’ choices.

I Remember that this was not the case in a dominant strategy

equilibrium. A player had one action that was the best regardless of
what the other player did.

I A Nash equilibrium is a profile of strategies such that each player’s

strategy is an optimal response to the other players’ strategy.
I We are going to introduce the concept of best response.

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Nash Equilibrium

Best Responses
I A strategy s0i ∈ Si is a best response to a strategy profile of other players
s−i ∈ S−i if for each si ∈ Si ,

ui (s0i , s−i ) ≥ ui (si , s−i ).

I The set of player i’s best response strategies to a strategy profile of other
players s−i is

βi (s−i ) = {s0i ∈ Si | for each si ∈ Si , ui (s0i , s−i ) ≥ ui (si , s−i )}.

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Best Responses
In the Game of Coordination
I Player 1 best response when player 2 goes U (Up) is U (Up), and the best
response when player 2 goes D (Down) is also D (Down).
Therefore, U ∈ β1 (U) and D ∈ β1 (D).

1/2 U D
U 1, 1 0, 0
D 0, 0 1, 1

I Player 2 best response when player 1 goes U (Up) is also U (Up), and the
best response when player 1 goes D (Down) is also D (Down).
Therefore, U ∈ β2 (U) and D ∈ β2 (D).

1/2 U D
U 1, 1 0, 0
D 0, 0 1, 1

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Best Responses

In the Location Game

I The best responses are illustrated in red for player 1 and orange for
player 2.

I For instance: 5 ∈ β1 (6) and 4 ∈ β2 (5).

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Nash Equilibrium

I A strategy profile s∗ ∈ S is a Nash equilibrium of a normal form game

(I, (Si )i∈N , (ui )i∈N ) if for each i ∈ I and each si ∈ Si ,

ui (s∗i , s∗−i ) ≥ ui (si , s∗−i ).

I The Nash equilibrium can be defined by using the best response

correspondences:

I A strategy profile s∗ ∈ S is a Nash equilibrium of a normal form

game (I, (Si )i∈N , (ui )i∈N ) if for each i ∈ I,

s∗i ∈ βi (s∗−i ).

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Nash Equilibrium
In the Coordination Game
I The intersection of best responses:

1/2 U D
U 1, 1 0, 0
D 0, 0 1, 1

I Has two Nash equilibria:

I One where both players go up and the other where both players go
down {(U, U), (D, D)}.
I For player 1, U ∈ β1 (U); D ∈ β1 (D).
I For player 2, U ∈ β2 (U); D ∈ β2 (D).

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Nash Equilibrium
Location Game
I The location game:

I Has a unique Nash equilibrium in which both firms locate in the

middle: location position 4, {(4, 4)}.

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2.4 Interpretation of Nash Equilibrium

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Interpretation of Nash Equilibrium
1. Fixed Point
I If players end-up at the equilibrium point they want to stay there (Static
interpretation).
I A Nash equilibrium in the normal form game G = (I, (Si )i∈I , (ui )i∈I ) is a
fixed point s∗ ∈ β(s∗ ).
I In the Prisoners’ Dilemma game, the fixed point (D, D) = β(D, D).
Thus, the unique Nash equilibrium is s∗ = {(D, D)}.

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Interpretation of Nash Equilibrium
1. Fixed Point
I In the Battle of Sexes, the fixed points are (F, F) = β(F, F) and
(B, B) = β(B, B). Thus, the two Nash equilibria are S∗ = {(F, F), (B, B)}.

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Interpretation of Nash Equilibrium

2. Consistent Prediction
I If players are rational and make consistent predictions they have to play
the Nash equilibrium.

I Consider the following game with two players who have three different
strategies.

1/2 L M R
u 3, 0 0, 2 0, 3
m 2, 0 1, 1 2, 0
d 0, 3 0, 2 3, 0

I Claim: the only consistent predictor is the unique Nash equilibrium

(m, M).

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Interpretation of Nash Equilibrium

2. Consistent Prediction

1/2 L M R
u 3, 0 0, 2 0, 3
m 2, 0 1, 1 2, 0
d 0, 3 0, 2 3, 0

I Consider the strategy profile s = (u, L)

I If player 2 was rational, given that player 1 plays u, it is better to
play M or R rather than L.
I In order for player 2 to play L he should be expecting player 1 to
play d.
I Hence, to justify s2 = L we need s1 = d.

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Interpretation of Nash Equilibrium

3. Social Stable Conventions

I Suppose that a player plays the same game repeatedly with different
players in a large population.

I If players’ behavior converges to a particular action profile, then it is

reasonable to think that it must be a Nash equilibrium.

I Examples are the way people move in the subway corridors or traffic in
highways, where car drivers use the right side of the road (in Australia
the convention is to drive on the left side of the road).

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2.5 Applications

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1. First-price sealed-bid auction

Environment
I A single object is to be assigned to a player in a set I = {1, 2, ..., n} in
exchange for a payment.

I Player i’s valuation is vi and assume v1 > v2 > ... > vn .

I All the players know the valuations of the rivals.

I Rules of the auction:

I (Sealed-bid) auction: the players simultaneously submit bids.

I The object is given to the player who submit the highest bid.
I (Tie-breaking): if the highest bid is submitted by a set of players,
the object is allocated to the player with the lowest index.
I The payment that the winner makes is the price that he bids.

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1. First-price sealed-bid auction

Strategies and Payoffs

I Each player i ∈ I, the strategy set Si = [0, ∞).

I The utility function is:

(
vi − bi if bi = max{b1 , b2 , ..., bn } and i = min{j|bj = max{b1 , b2 , ..., bn }}
ui =
0 otherwise.

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1. First-price sealed-bid auction
Equilibrium

I The set of Nash equilibrium in the auction consists of the strategy

profiles (bid profiles) b ∈ [0, ∞)n such that:

b1 ∈ [v2 , v1 ],
for each j ∈ I\{1}, bj ≤ b1 ,
there is j ∈ I\{1}, bj = b1 .

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1. First-price sealed-bid auction
Equilibrium

I The set of Nash equilibrium in the auction consists of the strategy

profiles (bid profiles) b ∈ [0, ∞)n such that:

b1 ∈ [v2 , v1 ],
for each j ∈ I\{1}, bj ≤ b1 ,
there is j ∈ I\{1}, bj = b1 .

I Note that in this equilibrium bidder 1 obtains the object.

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1. First-price sealed-bid auction
Proof of Nash Equilibrium

We will proceed by construction through different steps:

I Step 1: there is no equilibrium in which player 1 does not obtain the

object.
I Suppose that player i 6= 1 submits the highest bid bi , such that
b1 < bi .
I If bi > v2 , then player i’s payoff is negative, so he can increase his
payoff by bidding 0.
I If bi ≤ v2 , then player 1 can deviate by bidding bi and winning the
auction.
I Step 2: player 1 obtains the object with the winning bid b∗1 ∈ [v2 , v1 ].
I Then, b∗1 ≥ v2 , otherwise, player 2 can change his bid to some value
in the interval (b∗1 , v2 ) and increase the payoff.
I Also, it has to be that b∗1 ≤ v1 , otherwise, player 1 decreases his bid,
still wins the auction, and increase his payoff.
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1. First-price sealed-bid auction

Proof of Nash Equilibrium

I Step 3: there is another bidder making the bid bj = b∗1 , for some j 6= 1.
I Otherwise, player 1 increases his payoffs by decreasing the bid.
I This bidder does not gain by setting another bid.

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2. Cournot Model of Oligopoly
Environment
I We are going to model quantity competition between two firms.
I Firm 1 and Firm 2 produce an homogeneous good.
I Firms choose their output q = (q1 , q2 ) ∈ R2+ simultaneously.
I The market price is determined by the inverse demand function:
P(q1 + q2 ).
(
α − q1 − q2 if α > q1 + q2 ,
P(q) =
0 otherwise.

I Firm i’s profit is:

π(q) = P(q1 + q2 )qi − Ci (qi ).

I The cost of production Ci (qi ) = cqi , and let the parameters of the model
be strictly positive α > 0 and c > 0.

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2. Cournot Model of Oligopoly

The game

I We state the triplet of the normal form game G = (I, (Si )i∈I , (ui )i∈I ).

I The set of players in this game is I = {Firm 1, Firm 2}

I The set of strategies is Si = [0, ∞), that corresponds to the quantity each
firm decides to produce. (Competition in quantities).

I For each firm i, j ∈ {1, 2} and i 6= j, the utility function is the profit
function:
πi (qi , qj ) = (α − qi − qj )qi − cqi .

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2. Cournot Model of Oligopoly

To calculate the Nash equilibrium, we follow the next steps:

I Step 1: Calculate the best-response correspondence of each firm. The
first-order condition for the profit maximization problem is

∂πi α − qj − c
= α − 2qi − qj − c = 0 =⇒ qi = .
∂qi 2

I The best-response correspondence for firm i is

( α−q −c
j
2
if qj < α − c,
βi (qj ) =
0 otherwise.

I The best-response correspondence for firm j is similarly obtained

(
α−qi −c
2
if qi < α − c,
βj (qi ) =
0 otherwise.

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2. Cournot Model of Oligopoly
Graphical illustration
I Firm 1 profit as a function of the profile of quantities produced. Note
that the maximum form each profit function represent the best response
function.
56 Chapter 3. Nash Equilibrium: Illustrations

↑
π1 (q1 , q2 )
q2 = 0
q2 > 0

α−c
2 α−c
0 α−c−q2 α − c − q2 α q1 →
2

Figure 56.1 Firm 1’s profit as a function of its output, given firm 2’s output. The black curve shows the
case q 2 = 0, whereas the gray curve shows a case in which q 2 > 0.
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2. Cournot Model of Oligopoly

I Step 2: A Nash equilibrium of the game is when a strategy belongs to

the best response correspondence, i.e., q∗i ∈ βi (q∗j ) and q∗j ∈ βj (q∗i ).

α − q∗j − c α − q∗i − c
q∗i = , and q∗j = .
2 2

I Step 3: Easy calculations give:

α−q∗
i −c
α− 2
−c α−c α−c
q∗i = =⇒ q∗i = and q∗j = ,
2 3 3
and the unique Nash equilibrium is (q∗1 , q∗2 ) = α−c , α−c .


3 3

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 put with every output of firm 2, so we plot them relative to different axes. They
are shown in Figure 56.2 (b1 is black; b2 is gray). As for a general game (see Sec-
2.tion
Cournot Model each
2.8.3), b1 associates of Oligopoly
point on the vertical axis with a point on the hori-
zontal axis,
Graphical and b2 associates each point on the horizontal axis with a point on the
illustration
vertical axis.

↑
q2
α−c

b1 (q2 )

α−c
2

α−c (q∗1 , q∗2 )

3

b2 (q1 )

0 α−c α−c α−c q1 →

3 2

Figure 56.2 The best response functions in Cournot’s duopoly game when the inverse demand func-
tion is given by (54.2) and the cost Figure: Best
function of response
each firmfunction.
is cq. The unique Nash equilibrium is
(q ∗1 , q ∗2 ) = ( 31 (α − c), 13 (α − c)).
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3. Bertrand Model of Oligopoly
Environment
I We are going to model price competition between two firms.
I Firm 1 and Firm 2 produce an homogenous product.
I Each firm chooses the price for its product pi ∈ R+ simultaneously.
I Demand for each firm’s product qi depends on both prices
p = (p1 , p2 ) ∈ R2+ .
(
α − min {p1 , p2 } if min {p1 , p2 } ≤ α,
D(p) =
0 otherwise.

I Each firm i has constant marginal production costs Ci (qi ) = cqi , and the
profit for each firm i is:

(pi − c)(α − pi )
 if pi < pj ,
πi (p1 , p2 ) = 21 (pi − c)(α − pi ) if pi = pj ,
0 otherwise.



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 closer that price is to p j . For any price less th
is also less than p j , so there is no best price.
choose any number as its price; in particula
integral number of cents.) Thus Bi (p j ) is em
3. Bertrand Model of Oligopoly
• If p j > pm then pm is the unique best respon
To construct the best responses consider different cases: m
Figure 63.1): Bi (p j ) = {p }.
I Case 1: pj < c. The rival sets a price below the marginal cost of production.

↑ ↑
πi πi

pj
0 0
c pm α c p j pm

pi → pi
pj < c c < p j ≤ pm

Then, any price greater than pj is a best response to pj .

Figure 63.1 Three cross-sections (in black) of firm i’s payof
Where the payoff function jumps, its value is given by the sm
that are excluded as values of the functions.

In summary, firm i’s best response function is

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 closer that price is to p j . For any price less than p j there is a higher price th
is also less than p j , so there is no best price. (I have assumed that a firm c
choose any number as its price; in particular, it is not restricted to charge
3. Bertrand Model of Oligopoly
integral number of cents.) Thus Bi (p j ) is empty (has no members).
I Case 2: pj = c. The rival sets the price equal to marginal costs. Any price greater
pm then
• If p j or>equal than pp m is the
j , yields unique
a profit best
of zero, andresponse of firm
hence is a best i (see
response to pthe
j. right panel
Figure m
I Case63.1):
3: c < B
pji (p
≤ pj m) .=
The{prival}.sets the price between marginal costs and
monopoly pricing.

↑ ↑ ↑
πi πi πi

pj
0 0 0
c pm α c p j pm α c pm pj

pi → pi → pi
pj < c c < p j ≤ pm p j > pm

There is no best response: firm i wants to choose a price less than pj , but is better
Figure 63.1offThree cross-sections
the closer this price (in
is toblack)
pj . Forofany
firm payoff
i’s less
price thanfunction
pj , there in
is aBertrand’s duopoly gam
higher price
Where the payoff
that isfunction
also less jumps,
than pj , its
so value
there isisno
given
best by the Hence,
price. small disk;
Bi (pj )the small circles indicate poi
is empty.
that are excluded as values of the functions.

In summary, firm i’s best response function is given by 54 / 99

 there is no best price. (I have assumed that a firm can
its price; in particular, it is not restricted to charge an
nts.) Thus Bi (p j ) is empty (has no members).
3. Bertrand
he unique Model
best response of iOligopoly
of firm (see the right panel of
m
{p }.
I Case 4: pj > pm . The rival sets the price above the monopoly price.

↑ ↑
πi πi

0 0
c p j pm α c pm pj α

pi → pi →
c < p j ≤ pm p j > pm

The monopoly
(in black) of firm i’s payoff price pm isinthe
function unique best
Bertrand’s response
duopoly of firm i.
game.
its value is given by the small disk; the small circles indicate points
unctions.

t response function is given by

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3. Bertrand Model of Oligopoly

I Collecting the results from the different case:

I The best response correspondence for firm i is:

pi > pj if pj < c,



p ≥ c if pj = c,

i
βi (pj ) =
∅
 if c < pj ≤ pm ,
 m
if pj > pm .

p

I Similarly, the best response correspondence for firm j is

pj > pi if pi < c,



p ≥ c if pi = c,

j
βj (pi ) =

∅ if c < pi ≤ pm ,
 m
if pi > pm .

p

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 on the right). The shaded gray area in the left panel indicates that for a price p2 less
than c, any price greater than p2 is a best response for firm 1. The absence of a black
line along the sloping left boundary of this area indicates that only prices p1 greater
(not equal to) p2 are included. The black line along the top of the area indicates
3. than
Bertrand Model of Oligopoly
that for p2 = c any price greater than or equal to c is a best response. As before, the
Idot indicates a point
Illustration of thethat
bestis responses
included, whereas the small circle indicates a point that
is excluded. Firm 2’s best response function has a similar interpretation.

↑ ↑
p2 p2

pm pm
B2 (p1 )

B1 (p2 )
c c

0 c pm p1 → 0 c pm p1 →

Figure 64.1 The firms’ best response functions in Bertrand’s duopoly game. Firm 1’s best response
The intersection
function offirm
is in the left panel; the2’sbest
is in response correspondence is a unique point.
the right panel.
The Nash equilibrium of the Bertrand model of duopoly is
(p∗1 , p∗2 ) = (c, c).

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4. Voluntary Contribution of a Public Good
Environment
I A community with the set of players: I = {1, 2, ..., n} who consider
contributing to a public good.
I Each player i ∈ I, can make any contribution of a positive amount of
money xi .
I The set of strategies is Si = [0, ∞).
I For each player i ∈ I, the utility function is:
v
u n
uX
Ui (x1 , x2 , ..., xn ) = ω − xi + t xj .
j=1

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4. Voluntary Contribution of a Public Good

I The best-response correspondence for any player i is obtained by

calculating the first-order condition for the utility maximization:

n
∂Ui 1 X 1 1 X
= −1 + qP = 0 =⇒ xj = =⇒ xi = − xj
∂xi 2 n 4 4
j=1 xj j=1 j6=i

1 X
=⇒ Bi (x−i ) = − xj .
4
j6=i

I Focusing on a symmetric equilibrium i ∈ N, x∗i = x∗ .

In equilibrium x∗ = 14 − j6=i x∗ . Each player i ∈ N, contributes to the

P
I
1
amount x∗i = x∗ = 4n and the symmetric Nash equilibrium is

1 1 1
 
(x∗1 , x∗2 , ..., x∗n ) = , , ..., .
4n 4n 4n

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2.6 The Mixed Extension

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The Game of Matching Pennies

I Consider the game of matching pennies.

I In this game two players have to simultaneously decide the side of a

penny.

I If both sides coincide, player 2 must give his penny to player 1; if they
do not coincide player 1 must give his penny to player 2.

1/2 H T
H 1, −1 −1, 1
T −1, 1 1, −1

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The Game of Matching Pennies

I The best responses in this game can be represented in the matrix:

1/2 H T
H 1, −1 −1, 1
T −1, 1 1, −1

I In the game of Matching Pennies there is no fixed point. Thus there exist
no Nash equilibrium. For any player i, s∗i ∈
/ βi (s∗−i ).

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The Game of Matching Pennies

I If the predicted outcome is that the announcement will match, player 2

has an incentive to deviate, while player 1 would prefer to deviate from
any prediction in which announcements do not match.

I Question: does the game has an equilibrium?

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The Mixed Extension

I So far we have considered situations when a player plays for sure a

given strategy or action.

I There are many examples in which it is in the advantage of a player to

be “unpredictable".

I If a traffic car police was always placed at the same junction, its
effectiveness would be reduced.
I If Messi shoots the penalties always to the left of the goalkeeper, he
would score less goals (He will still score goals, remember he is the
best player in history).

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The Mixed Extension
Notation
I Consider the normal form game G = (I, (Si )i∈I , (ui )i∈I ).

I Extend the player’s strategy sets by allowing them to randomize over

their strategies.

I σi the probability distribution over the finite set of strategies,

Si : σi = (σi (si ))si ∈Si .

I The number σi (si ) is the probability of playing strategy si .

I We call σi ∈ ∆(Si ) the mixed strategy and si ∈ Si the pure strategy.

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The Mixed Extension
Payoffs
I Because players utilities are linear in probabilities,Q the players expected
payoffs given the profile of mixed strategy σ ∈ j∈I ∆(Sj ) are the
expected values of the corresponding pure-strategy payoffs. Any player
i obtains
XY
ui (σ) = σj (sj )ui (s),
s∈S j∈I

which is equivalent to

X
ui (σ) = σi (si )ui (si , σ−i ).
si ∈Si

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The Mixed Extension
Equilibrium
I The strategic form game G = (I, (∆(Si ))i∈I , (ui )i∈I ) is theQmixed
extension of the game G = (I, (Si )i∈I , (ui )i∈I ) where ui : j∈I ∆(Si ) → R

I The mixed strategy σ ∗ is an equilibrium in mixed strategies of the

normal form game (I, (∆(Si ))i∈I , (ui )i∈I ) if and only if for every player
i ∈ I and every pure strategy si ∈ Si

ui (σ ∗ ) ≥ ui (si , σ−i
∗
).

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2.6.1 Computation of Equilibria in Mixed
Strategies

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Computation of Equilibria in Mixed Strategies
The Indifference Principle
I When the number of strategies is large, finding an equilibrium in mixed
strategies is theoretically and computationally quite difficult.

I We compute equilibria in simple games by using the indifference

principle.

Definition
Indifference principle: If a mixed equilibrium calls for a player to use two
distinct pure strategies with positive probability, then the expected payoff to
that player for using one of those pure strategies equals the expected payoff
to him for using the other pure strategy.

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Computation of Equilibria in Mixed Strategies
The Indifference Principle

Theorem
Let σ ∗ be an equilibrium in mixed strategies of a strategic form game
and let si and s0i be two pure strategies of player i. If σi∗ (si ) > 0 and
σi∗ (s0i ) > 0.
ui (si , σ−i
∗
) = ui (s0i , σ−i
∗
).

I Otherwise, the player will not play any of those actions with
positive probability.

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Computation of Equilibria in Mixed Strategies
The Battle of Sexes

I The matrix representation.

m/w F B
F 2, 1 0, 0
B 0, 0 1, 2

I This game has two pure strategy Nash equilibria (F, F) and (B, B).

I Denote σ1 the probability that player 1 plays F, and (1 − σ1 ) the

probability that player 1 plays B.

I Denote σ2 the probability that player 2 plays F, and (1 − σ2 ) the

probability that player 2 plays B.

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Computation of Equilibria in Mixed Strategies
The Battle of Sexes
I Given the mixed strategy σ2 , applying the indifference condition player
1 should be indifferent between playing F and B,

u1 (F, σ2 ) = u1 (B, σ2 ) ⇐⇒ 2 × σ2 + 0 × (1 − σ2 ) = 0 × σ2 + 1 × (1 − σ2 ).

I This gives σ2 = 1/3. Then, the best response correspondence B1 (σ2 ) is

if σ2 > 31 ,

σ1 = 1 (Play F)

B1 (σ2 ) = σ1 ∈ [0, 1] (Indifferent) if σ2 = 31 ,
σ1 = 0 (Play B) if σ2 < 31 .



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Computation of Equilibria in Mixed Strategies

Graphical Representation of Best Response Function

σ2
1

2
3 B1 (σ2 )

1
3

σ1
1 2
3 3 1

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Computation of Equilibria in Mixed Strategies
The Battle of Sexes
I Given the mixed strategy σ1 , applying the indifference condition player
2 should be indifferent between playing F and B,

u2 (σ1 , F) = u2 (σ1 , B) ⇐⇒ 1 × σ1 + 0 × (1 − σ1 ) = 0 × σ1 + 2 × (1 − σ1 ).

I This gives σ1 = 2/3. Then, the best response correspondence B2 (σ1 ) is

if σ1 > 32 ,

σ2 = 1 (Play F)

B2 (σ1 ) = σ2 ∈ [0, 1] (Indifferent) if σ1 = 32 ,
σ2 = 0 (Play B) if σ1 < 32 .



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Computation of Equilibria in Mixed Strategies

Graphical Representation of Best Response Function

σ2
1

2
3 B2 (σ1 )

1
3

σ1
1 2
3 3 1

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Computation of Equilibria in Mixed Strategies
I A Nash equilibrium is σi∗ ∈ Bi (σ−i
∗
).
I This is equivalent to the points at which the two graphs B1 (σ2 ) and
B2 (σ1 ) intersect.
σ2
1

2
3 B2 (σ1 ) B1 (σ2 )

1
3

σ1
1 2
3 3 1

I The game of the battle of sexes has three mixed strategy equilibria.

(σ1 ,σ2 ) = ((σ1F , σ1B ), (σ2F , σ2B )) :

2 1 1 2
    
MSNE = (σ1 , σ2 ) | ((0, 1), (0, 1)) ; ((1, 0), (1, 0)) ; , , ,
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Computation of Equilibria in Mixed Strategies
Matching Pennies
I The game
1/2 H T
H 1, −1 −1, 1
T −1, 1 1, −1

I Does not have an equilibrium in pure strategies.

I Denote σ2 the probability that player 2 plays H, and (1 − σ2 ) the

probability that player 2 plays T.

I Denote σ1 the probability that player 1 plays H, and (1 − σ1 ) the

probability that player 1 plays T.

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Computation of Equilibria in Mixed Strategies
Matching Pennies
I Applying the indifference principle: given σ2 , player 1 is indifferent
between both pure strategies when

u1 (H, σ2 ) = u1 (T, σ2 ) ⇐⇒ 1 × σ2 − 1 × (1 − σ2 ) = −1 × σ2 + 1 × (1 − σ2 ).

I This gives σ2 = 1/2. Then, the best response correspondence B1 (σ2 ) is

if σ2 > 21 ,

σ1 = 1 (Play H)

B1 (σ2 ) = σ1 ∈ [0, 1] (Indifferent) if σ2 = 21 ,
σ1 = 0 (Play T) if σ2 < 21 .



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Computation of Equilibria in Mixed Strategies
Matching Pennies
I Given σ1 player 2 is indifferent

u2 (σ1 , H) = u2 (σ1 , T) ⇐⇒ −1 × σ1 + 1 × (1 − σ1 ) = 1 × σ1 − 1 × (1 − σ1 ).

I This gives σ1 = 1/2. Then, the best response correspondence B2 (σ1 ) is

if σ1 > 21 ,

σ2 = 0 (Play T)

B2 (σ1 ) = σ2 ∈ [0, 1] (Indifferent) if σ1 = 21 ,
σ2 = 1 (Play H) if σ1 < 21 .



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Computation of Equilibria in Mixed Strategies
Matching Pennies
I The graphical representation of best responses

σ2
1

B2 (σ1 ) B1 (σ2 )

1
2

1
σ1
2 1

I The only “stable" situation is when each player randomizes between his
two pure strategies, assigning equal probability to each.

1 1 1 1
   
(σ1 , σ2 ) = ((σ1H , σ1T ), (σ2H , σ2T )) : MSNE = , , , .
2 2 2 2
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Computation of Equilibria in Mixed Strategies
Rock, Paper, Scissors

I Each player choose simultaneously one of the following: Rock, Paper or

Scissors.
I The Rock beats Scissors, Scissors beats Paper, and the Paper beats the
Rock.

1/2 R P S
R 0, 0 −1, 1 1, −1
P 1, −1 0, 0 −1, 1
S −1, 1 1, −1 0, 0

I This game does not have an equilibrium in pure strategies.

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Computation of Equilibria in Mixed Strategies
Rock, Paper, Scissors
I If player 2 plays R with probability σ2R , plays P with probability σ2P ,
and S with probability σ2S . Player 1 must be indifferent between playing
any pure strategy equilibrium.

u(R, σ2 ) = u(P, σ2 ) ⇐⇒ −1 × σ2P + 1 × σ2S = 1 × σ2R − 1 × σ2S

u(P, σ2 ) = u(S, σ2 ) ⇐⇒ 1 × σ2R − 1 × σ2S = −1 × σ2R + 1 × σ2P
σ2R + σ2P + σ2S = 1.

I We have three equations with three unknowns. The unique solution of

the program is
1
σ2R = σ2P = σ2S = .
3

I Similarly, by calculating the expected payoff of player 2 we obtain

1
σ1R = σ1P = σ1S = .
3
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2.6.2 Justification of Mixed Strategies

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Justification of Mixed Strategies

I Deliberate Choice: A deliberate decision by a player to introduce

randomness into his behavior. Players are literally randomizing or
choosing a randomization device. (ex. poker players randomly bluff,
governments randomly audit...).

I Adaptation and Average Behavior: It is a description of average

behavior when players follow some adaptive process. (Steady state
where you can check past frequency).

I Population Interpretation: People play the same game with different

players over time and a mixed strategy is just a distribution of different
pure strategies in population (ex. a half people play H and a half people
play T).

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2.6.3 Field Experiments on Mixed Strategies

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Field Experiments on Mixed Strategies
Wimbledon

I Walker and Wooders (2001) (Minimax Play at Wimbledon, The American

Economic Review Vol. 91, No. 5 pp. 1521-1538) examined top tennis
players’ behavior in Wimbledon games.

I Matching Pennies: the server (S) decides whether to serve on the right
hand side of the receiver (R) or on the left hand side of the receiver. The
receiver decides whether to move to the right or the left.

I S’s optimal choice is to choose the different side from what R chooses.
R’s optimal choice is to choose the same side as what S chooses.

If the theory is correct, the server must obtain the same expected points
between serving to either side.

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Field Experiments on Mixed Strategies
Wimbledon

I The expected point conditional on serving to the right or serving to the

left were found to be roughly the same.

I The theory predicts that players randomize independently over periods.

In reality, players switch sides “too much”.

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Field Experiments on Mixed Strategies
Penalty Kick

I Chiappori, Levitt and Roseclose (2002) (Testing Mixed-Strategy

Equilibria When Players Are Heterogeneous: The Case of Penalty Kicks
in Soccer, The American Economic Review) study the mixed strategy in
penalty kick.

I Two players (a kicker and a goalie) participate in a zero-sum game.

I Kicker’s possible actions can be reasonably summarized as kicking to either

the right, middle, or left side of the goal.
I The goalie can either jump to the right or left, or remain in the middle.

I The kicker wants to maximize the probability of a score and the goalie
wants to minimize scoring.

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Field Experiments on Mixed Strategies
Penalty Kick
I The authors use a data set that includes virtually every penalty kick
occurring in the French and Italian elite leagues over a period of three
years - a total of 459 kicks.

I Why the goalkeeper does not stay in the middle?

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2.7 General Existence Theorems

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General Existence Theorems

I Existence of equilibrium is an important property of a game:

I Without existence, is very hard to predict what is going to happen
in a game.

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General Existence Theorems

I To show that a game has a Nash equilibrium it suffices to show that

there exist a profile s∗ of strategies such that s∗i ∈ Bi (s∗−i ) for all i ∈ I.

I As in the case of Matching Pennies, a game may fail to have an

equilibrium in pure strategies.

I By extending the strategy set to mixed strategies, any finite game has
always an equilibrium as shown by John Nash.

Theorem
(Nash 1950b) Every game in which each player has a finite number of pure
strategies has at least one equilibrium (possibly in mixed strategies).

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General Existence Theorems
Proof of Nash Theorem: fixed point

I Extending the strategy set to mixed strategies, for every player i ∈ I we

define the best-response correspondence for player i, Bi : ∆S → ∆Si as

Bi (σ−i ) = σi ∈ ∆Si | ui (σi , σ−i ) ≥ ui (σi0 , σ−i ) for all σi0 ∈ ∆Si .


I Then, the best-response correspondence B : ∆S → ∆S for every σ ∈ ∆S

B(σ) = (B1 (σ), · · ·, Bn (σ)) .

I The set of Nash equilibria of the game is the set of fixed points of B

σ ∗ ∈ ∆S∗ if and only if σ ∗ ∈ B(σ ∗ ).

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General Existence Theorems
Kakutani’s theorem.
I We then need a theorem for fixed point in correspondences. This is
provided by the Kakutani’s theorem.

Theorem
(Kakutani) Let X be a non-empty, subset of Rk , and let f : X → X be a
correspondence satisfying the following conditions:
i) X is a compact and convex set.
ii) f (x) is non-empty for all x ∈ X.
iii) f (x) is a convex-valued correspondence: for all x ∈ X, f (x) is a convex set.
iv) f (x) has a closed graph: that is, if {xn , yn } → {x, y} with yn ∈ f (xn ), then
y ∈ f (x).
Then, the correspondence f has a fixed point, that is, there exists some x ∈ X,
such that x ∈ f (x).

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General Existence Theorems
Proof of Kakutani’s theorem.
I i) The set ∆S is compact, convex and non-empty.

By definition ∆S = ∆Si .
Q
I
i∈I

I Because, thePstrategy set is finite, then each mixed strategy set

∆Si = {σ | j σj = 1} is a simplex of dimension | Si | −1.
I Hence, each ∆Si is closed and bounded, and this compact. Their
product is also a compact set.

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General Existence Theorems
Proof of Kakutani’s theorem.
I ii) The best-response correspondence B(σ) is non-empty.

I By definition,
Bi (σ−i ) = arg max ui (x, σ−i ),
x∈∆Si

where ∆Si is non-empty and compact, and ui is linear in x.

I Hence ui is continuous.
I By the Weirstrass’s theorem it always exists a solution to the
previous optimization problem.
I Then, B(σ) is non-empty.

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General Existence Theorems
Proof of Kakutani’s theorem.
I iii) The best-response correspondence B(σ) is convex valued.
I Observe that B(σ) is convex if and only if Bi (σ−i ) is convex for all i.
Let σi0 , σi00 ∈ Bi (σ−i ). Then,
ui (σi0 , σ−i ) ≥ ui (τi , σ−i ) for all τi ∈ ∆Si ,
ui (σi00 , σ−i ) ≥ ui (τi , σ−i ) for all τi ∈ ∆Si .

I For all λ ∈ [0, 1], it has to be that

λui (σi0 , σ−i ) + (1 − λ)ui (σi00 , σ−i ) ≥ ui (τi , σ−i ) for all τi ∈ ∆Si .

I Due to the linearity of ui

ui λσi0 + (1 − λ)σi00 , σ−i ≥ ui (τi , σ−i ) for all τi ∈ ∆Si .

I Therefore, λσi0 + (1 − λ)σi00 ∈ Bi (σ−i ).

I This shows that the best-response correspondence B(σ) is
convex-valued.
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General Existence Theorems
Proof of Kakutani’s theorem.
I iv) The best-response correspondence B(σ) has a closed graph.

I We are going to proceed by contradiction. Suppose that B(σ) does not have
a closed graph.
I Then, there exists a sequence (σ n , σ̂ n ) → (σ, σ̂) with σ̂ n ∈ B(σ n ) but
/ B(σ), i.e., there exist some i such that σ̂i ∈
σ̂ ∈ / Bi (σ−i ).
I This implies that there exist σi0 ∈ ∆Si and some  > 0 such that

ui (σi0 , σ−i ) > ui (σ̂i , σ−i ) + 3.

I The continuity of ui and the sequence σ−i n → σ , we have that for

−i
sufficiently large n
n
ui (σi0 , σ−i ) ≥ ui (σi0 , σ−i ) − .
I Combining both relations we obtain
n
ui (σi0 , σ−i ) > ui (σ̂i , σ−i ) + 2 ≥ ui (σ̂in , σ−i
n
) + ,
where the last inequality comes form the continuity of ui .
I This expression contradicts the assumption that σ̂in ∈ Bi (σ−i
n ) - we reach to

a contradiction.

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General Existence Theorems
Existence

I With the application of the Kakutani’s fixed point theorem for

correspondences, we show that the existence of a mixed strategy
equilibrium is guaranteed in any finite normal-form game.

I What about when players have an infinite number of strategies?

I Equilibrium does not always exists in this case. Example: name an
integer, the highest integer earns a price, if a tie then a coin is
flipped to decide which player wins.

I Existence of Nash equilibrium is an active area of research. You need to

put structure in the game to guarantee existence if equilibrium.

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