Game Theory

Lecture 6

Leong Kaiwen

Assistant Professor in Economics

Nanyang Technological University

2021

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Coordination Game

Lesson: Communication can help in a coordination game.

There is a ”scope” for leadership in communication games.
Example
Player 2
l r
u (1,1) (0,0)
Player 1
d (0,0) (1,1)
You want to coordinate on (u,l) or (d,r). You don’t want to end up
coordinated on (u,r) or (d,l).
In this game, if you just played it, it’s quite likely you are going to end
up uncoordinated on the bad outcomes. But if you have a little bit of
leadership can say (u,l) or (d,r) is where we coordinate, this matters a
lot.

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Investment Game
In investment game, one feature of the game was that the more you
thought other people were going to invest, the more you wanted to
invest.
Recall in the partnership game, you were contributing effort to a joint
project. In that game, the best responses looked like,

This game also has the feature the

more the other person does, the more
you want to do.

Jargon: Investment game and partnership game are games with strate-
gic complements.
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Going to the Movies

A couple is going to meet up at the movies. They forget to tell each

other which movie to go to.
Player 2
BU GS SW
Boume Ultimation (BU) (2,1) (0,0) (0,-1)
Player 1
Good Sherpard (GS) (0,0) (1,2) (0,-1)
Snow White (SW) (-1,0) (-1,0) (-2,-2)

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Going to the Movies

For player 1, the best outcome is both players go to BU. Second best
outcome is coordinate on GS. Worse outcome is coordinate on SW
because the couple has to talk about it at coffee.
For player 2, the best outcome is coordinate on GS, then BU. The
disaster outcome is to fail to coordinate and see different movies.
For both players, SW is strictly dominated. Hence we can eliminate
SW for both players. Hence, the game is now as follows.
Player 2
BU GS
BU (2,1) (0,0)
Player 1
GS (0,0) (1,2)

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Going to the Movies

Now, let us allow communication before the start of the game.

Communication in this game worked, but it wasn’t an instant solution.
This game is a little bit harder to get communication. Why?
NE: (BU,BU), (GS,GS)
The previous coordination games were pure coordination problems. There
was no conflict at all.
But in this particular game, there is a potential source of conflict. The
example msg stating ”I am going to BU” is good because it fixed the
outcome. This game without communication is known as ”Battle of the
sexes”.
But if the example msg was not what was said by player 1, communica-
tion might have broken down and there could have been a negotiation,
eg. strike.

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Cournot Duopoly

In this game, there are 2 players, each with many strategies.

There are 2 firms competing in the same market. This case lies between
perfect competition & monopoly. Most markets are like this.
We are interested in 2 things.
What is going to happen in the markets?
Policy reason: we want to know if this is good for consumers/producers-
how it relates to profits and consumer surplus.

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Cournot Duopoly

Game
Players: 2 firms
Strategies:quantities they produce of an identical product. The prod-
ucts are perfect substitutes: qi , q−i
Cost of production: c ∗ q (constant marginal cost)
Prices: a-b(q1 +q2 )
Payoffs: firms aim to maximize profits
U1 (q1 , q2 ) = pq1 − cq1
U1 (q1 , q2 ) = aq1 − bq12 − bq1 q2 − cq1

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Cournot Duopoly

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Cournot Duopoly

Now we want to find NE:

To find BR: want to know what is the q1 that maximizes profits for
each q2
dU1
FOC: = a − 2b qb1 − bq2 − c = 0
dq1
SOC: -2b<0 (we are indeed finding a max & not a min)
a−c q2
Hence BR1 (q2 ) = qb1 = −
2b 2
Similarly BR2 (q1 )=(a-c)/(2b)-q1 /2

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Cournot Duopoly

Lets draw the BRs.

NE:player 1 is playing BR to 2. And player 2 is playing BR to 1.

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Cournot Duopoly

a−c q∗
q1∗ = − 2
2b 2
a − c q ∗
q2∗ = − 1
2b 2
a−c
Solving yields: q1∗ = q2∗ =
3b
This is called the Cournot quantity.
What is the difference in these BR pictures compared to the partnership
game?

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Cournot Duopoly

What is the difference in these BR pictures compared to the partnership

game?
In this partner game, BR lines slopped up. The more I did of my strategy,
the more the other player did as a best response.
In the investment game, the more likely I was to invest, the more you
wanted to invest.
But in this game, we have the exact opposite. The more player 1 pro-
duces, the less player 2 wants to produce. The more 2 produces, the less
1 wants to produce.
This Cournot duopoly game is not of strategic complements but of strate-
gic substitutes.
My strategy is a strategic substitute of your strategy if the more I do of
my strategy the less you want to do of yours.

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Cournot Duopoly
Will total industry profits be maximized when these firms play NE?
Where on the picture maximise total industry profits?

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Cournot Duopoly

If we produce the monopoly quantity, we maximize industry profits.

If firm 2 shut down & firm 1 produced q1M , this would maximize industry
profits.
Similarly if form 1 shut down & firm 2 produced q2M , this would also
maximize industry profits.
If the firms wanted to make more money, one thing they could do was
sign up an agreement saying each of them would not produce Cournot
quantity but produce 1/2 monopoly quantity each. What is wrong with
this agreement?

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Cournot Duopoly

What is wrong with this agreement?

q2M
It is illegal. If 1 believe that player 2 will indeed produce , player
2
qM
1 will produce BR1 ( 2 ). Notice that this quantity is much higher
2
than the Cournot quantity. But since 2 knows that 1 will produce
M
q qM
BR1 ( 2 ), 2 will produce BR2 [BR1 ( 2 )]. Then 1 knowing this will
2 2
q2M
produce BR1 [BR2 [BR1 ( )]]. If we keep going like this, we will end up
2
at the NE which is the Cournot outcome.
Even if the 1 firms could sign a contract restricting output thus making
profits, there would be new entrants into the market. A competitive
fringe of firms will enter and drive prices down.
Oil is a good example.

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Cournot Duopoly

Back to game
2(a − c)
Total quantity produced in NE:
3b
a−c
Competitive quantity produced:
b
a−c
Monopoly quantity produced:
2b
⇓
Competitive quantity > Cournot quantity(NE) > Monopoly quantity
Competitive price < Cournot price < Monopoly price

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