Game Theory

Lecture 5

Leong Kaiwen

Assistant Professor in Economics

Nanyang Technological University

2021

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Nash Equilibrium Definition

A strategy profile (s∗1 ,s∗2 ,...,s∗n ) is a NE if for each player i, her choice s∗i
is the best response to the other players choices s∗−i .
Note: Everyone is playing a BR to everyone else.
This is by far the most commonly used solution concept in game theory.
It is not always going to be the case that people play NE. For example,
the number game in lecture 2. The NE is 1. But when people actually
played the game, the average is much higher like 13.
Motivations: why NE is important?

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Nash Equilibrium Definition

Motivations: why NE is important?

Idea of no regrets: suppose we are looking at a NE, if we hold the
strategies of everyone else fixed, no individual i has any strict incentive
to deviate. In other words, no individual can do strictly better by
deviating, holding fixed everyone else’s actions.
Suppose you play a NE and you looked back at what you have done
and you know what everyone else has done and you say ”Do I regret my
actions ?”
No, I don’t regret my actions because I did the best I could given what
they did.
NE can be thought of as self-fulfilling beliefs.
In previous lectures, we talked about beliefs. If I believe the goal keeper
is going to dive this way, I should shoot that way and so on.

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Nash Equilibrium Definition

For NE: If I believe that if everyone in the game believes that everyone
else is going to play their part of a particular NE then everyone will in
fact pay their part of that NE. Why?

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Nash Equilibrium Definition

For NE: If I believe that if everyone in the game believes that everyone
else is going to play their part of a particular NE then everyone will in
fact pay their part of that NE. Why?
The reason is that if I think players 2 to N are going to play s∗2 ,...,s∗n ,
then by definition my best response is to play s∗1 so in fact I will play
my part in the NE.

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Recall Partnership Game in Lecture 4

Note: If player 1 believe 2 will chose x, he should choose y. This is what it

means to be a best response.

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Recall Partnership Game in Lecture 4

Self-fulfilling beliefs: If player 1 believes that player 2 is playing exactly her

Nash strategy then player 1’s best response is to respond by his Nash strategy.
Conversely, if player 2 thinks player 1 is playing his Nash strategy s∗1 , then
player 2’s BR is to play her Nash strategy. This is indeed a self-fulfilling belief.
No regrets: player 1 wakes up the next morning and he says I choose s∗1 , do
I regret this? 1 now knows what player 2 chose(s∗2 ) and 1 says no, I don’t
regret anything as that is the best I could have done. That in fact was 1’s
best response.
Note: This no regret idea would not be true at any other outcome. For
example,if 1 had chosen s∗1 and 2 had chosen X. Then player 1 would have
regrets. Player 1 would wake up the next morning and say I thought player 2
was going to play s∗2 but she played X instead. I regret having chosen s1∗ . I
would have rather chosen y. Only at NE will there be no regrets

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Find NE in Simple Games

Player 2
l c r
U (0,4) (4,0) (5,3)
Player 1
M (4,0) (0,4) (5,3)
D (3,5) (3,5) (6,6)
How to find NE in this game?
Similar to what we did in partnership game.
Idea: we figure out player 1’s best response to what 2 was doing. We
also figure out player 2’s best response to what 1 was doing. We looked
at the intersection of the 2 BR curves and that was NE.

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Find NE in Simple Games

We are going to do the exact same thing in this simple game. We are
going to figure out player 1’s best response.
BR1 (l) = M (4 is bigger than 0 & 3, 2 chooses l)
BR1 (c) = U
BR1 (r) = D
Notice that each of player 1’s strategies is a best response to some-
thing. So noting would be eliminated by our domination arguments and
nothing would be knocked out by our never a best response arguments
for player 1.
BR2 (U) = l (4 is bigger than 3 & 0)
BR2 (M) = c
BR2 (D) = r
NE here is (D,r). At this point 2 is playing a BR to 1 and 1 is playing
a BR to 2.

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Another Example

Player 2
l c r
U (0,2) (2,3) (4,3)
Player 1
M (11,1) (3,2) (0,0)
D (0,3) (1,0) (8,0)
Find NE: For each player, figure out their best responses for each pos-
sible choice of the other player.
BR1 (l) = M BR2 (U) = c or r (Note: best responses need not to be
unique.)
BR1 (c) = M BR2 (M) = c
BR1 (r) = D BR2 (d) = l
NE = (M,c) because each player is playing a best response to each other.

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How is NE Related to Dominance?

Prisoner’s dilemma

Player 2
α β
α (0,0) (3,-1)
Player 1
β (-1,3) (1,1)
In this game β is strictly dominated by α.
If 2 plays α, α is better than β for 1.
If 2 plays β,α is better than β for 1.
So α is better for 1 in either case.

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How is NE Related to Dominance?

Find NE for this game

BR1 (α) = α, BR2 (α) = α
BR1 (β) = α, BR1 (β) = α
Player 2
α β
α (0,0) (3,-1)
Player 1
β (-1,3) (1,1)
So NE is (α,α)
NE and elimination of dominated strategies yield the same outcome here.

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How is NE Related to Dominance?

Claim: No strictly dominated strategy could ever be played in a NE.

A strictly dominated strategy isn’t a best response to anything. In par-
ticular, the thing that dominates it always dose better. So it cannot be
a best response to the thing that is being played in the NE.
Unfortunately, the above is not true for weakly dominated strategies!
Example:

Player 2 BR1 (l) = U, BR1 (r) = U or D

l r BR2 (U) = l, BR2 (D) = l or r
U (1,1) (0,0) Both(U,l) & (D,r) are NE (no player
Player 1
D (0,0) (0,0) has a strict incentive to deviate)

Key: Sometimes will get many NE in a game. But it seems that (U,l)
is a sensible prediction but (D,r) is not.

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Investment Game

How to find NE in a game with many players(>2) but each player only has
a few strategies.
players: everyone in the class
strategy set: invest 0 or invest $10
If you do not invest, then you get $0. If you invest, there are two
possibilities. First, if more than or equal to 90% of the class invest,
then you get a net profit of $5. To illustrate, you receive $15 and
you pay $10. Therefore, you actually earn a profit of $5. Second, you
receive a net loss of -$10, if less than 90% of the entire class invest.
No communication. Cannot talk to each other.
Write whether you are going to invest or not.

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Investment Game

What are the NE in this game?


all invest
NE =
no one invest

Why all invest is NE?

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Investment Game

What are the NE in this game?


all invest
NE =
no one invest

Why all invest is NE?

If everyone invests, no one would have any regrets and everyone’s best
response would be to invest.
Why no one invests is NE?

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Investment Game

What are the NE in this game?


all invest
NE =
no one invest

Why all invest is NE?

If everyone invests, no one would have any regrets and everyone’s best
response would be to invest.
Why no one invests is NE?
If no one invests, then everyone would be happy not to have invested,
that would be a best response.

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Investment Game

Remark: How did we find these 2 NE?

We used guess and check. Guessing is hard because you might miss an
NE. Checking is easy because all you are doing is making sure no one
wants to move away.
Guessing and checking are very useful methods in games where there are
many players and each player only has a few strategies.
Let’s replay the game a few times
Play converged in the natural sense to NE where no one invested.

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Investment Game

Is one of the NE in this game better than the other?

The everyone investing NE is the better one for everyone in the class
compared to the one where everyone not investing.
However, observe when we replayed the game, we were converging rapidly
to a bad equilibrium. How did we converge to the bad equilibrium? (The
bad equilibrium is Pareto dominated by the good equilibrium. Everybody
is strictly better off at the good equilibrium compared to the bad equi-
librium.)
Why?

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Investment Game
Ans:Where we start off matters.
Suppose when we first played the game, 93 % of the class had invested.
Here, all these 93 % would have made money. My guess is repeated play
would have lead us to converge the other way to the good equilibrium.
Non investors in the first around would have regretted their choice and
they might have switched to investing.
If we started below the threshold, it is likely repeated play would have
converged to be the bad equilibrium where no one invests.
NE here concludes with the idea of a self-fulfilling prediction. Provided
you think other people are not going to invest, then you are not going
to invest. So it’s a self fulfilling prediction to take you down to not
investing. Conversely, provided everyone thinks everyone else is going
to invest, then you are going to invest and go to the good equilibrium.
Even though there is a bad outcome and we are likely to converge to it
if we start below the threshold of 90 %, this is not a prisoner’s dilemma.
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Investment Game

Why is this not a prisoner’s dilemma?

In prisoner’s dilemma, playing α was always a best response. What
leads to us to the bad outcome in prisoner’s dilemma was α (the non
cooperative strategy) was always the best thing to do.
In the current game, the ”moral” thing is to invest but it is not the case
that not investing dominates investing.
This is actually a coordination game. You would like everyone in the
class to coordinate their response on invest. If everyone did that everyone
would be happy and no one would have an incentive to defect and that
would be an equilibrium.

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Investment Game

There are lots of coordination games in reality & most result in bad
outcomes.
A party: If everyone shows up it’s a good party & you want to go. If no
one shows up it’s a bad party & you don’t want to go.
Stock exchange: There are a few stock exchanges. If all of the companies
list on one exchange, they can share the fixed costs & everyone is better
off. But everyone might end up listing on the bad exchange.
Bank Run:
Good equilibrium: everyone has confidence in the bank, everyone leaves
their money in the bank. The bank is able to lend some of the money
out on a higher rate of interest on it.
Bad equilibrium: People lose confidence in the bank and start drawing
their deposits out, the bank does not have enough cash in the vaults to
cover those deposits and the bank goes under. Lots of banks run in US
before 1930s.

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Investment Game

Does communication affect prisoner’s dilemma and coordination games?

For example,
In the prisoner’s dilemma, if someone told the players choosing β makes
both players better off, they still would have chosen α because α is a
dominant strategy.
But in this investment game, if someone told everyone to invest, it will
work. The speaker is not trying to get people to pay a strictly dominated
strategy and more that that he is trying to encourage people to play a
NE.
In coordination games unlike prisoner’s dilemma, communication (no
contracts) can help. We can persuade each other to play the ”good”
NE.
In a prisoner’s dilemma, if we want to arrive at the good outcome, we
will need to use contracts, side payments (change the payoffs of the
game)

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Investment Game

Key: In coordination games, NE can be a self enforcing agreement.

We can agree to play ”invest” in this game and indeed we will play
”invest” without any side payments or contracts or punishment. we
will end up doing the right thing because it is in our own interest to do
so.

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