DD309 Online Tutorial 13th December 2021

Hedley Stone
Colin Cannon

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DD309 Online Tutorial
16th December 2020
• TMA02
– Part A - Game theory (25 marks)
– Part B – Econometrics (25 marks)
– Part C - Essay on competition policy (50 marks)

Programme for tonight

Game theory (mainly Hedley);
Econometrics; Essay (mainly Colin)
Game theory poll 1: basics
• Which of the following statements about game theory
are true?

• A) It uses an individualist approach

• B) It assumes that players do not always aim to
maximise their own pay-offs
• C) It studies strategic decision-making
• D) It assumes that a game is never played more than
once
• E) It shows that self-interest always leads to the optimal
outcome
• F) It assumes that players are rational
Game theory: basic
assumptions
• Which of the following statements about game theory
are true?
• A) It uses an individualist approach T
• B) It assumes that players do not always aim to
maximise their own pay-offs F
• C) It studies strategic decision-making
T
• D) It assumes that a game is never played more than
once F
• E) It shows that self-interest always leads to the optimal
F
outcome
• F) It assumes that players are rational T
Simultaneous games
• ‘Simultaneous’ means
• happening at the same time
• But in game theory it is not the time when decisions are
made that is crucial: it is the state of each player’s
knowledge of other players’ decisions
• In a simultaneous game, neither player knows what the
other player(s) intend to do
• What each player does know is all the possible pay-offs
of the game
Game theory poll 2: dominant
strategy
• A dominant strategy is:

• A) guaranteed to give a player the best of all the

possible pay-offs
• B) the best strategy for one player regardless of the
strategies of other players
Game theory:
Dominant strategy

• A dominant strategy is:

• A) guaranteed to give a player the best of all the

possible pay-offs
• B) the best strategy for one player regardless of the
*
strategies of other players
The prisoners’ dilemma
• A well-known example of a game where pursuing the
dominant strategy leads to a sub-optimal outcome is the
prisoners’ dilemma

• There are two shops, Debs and Marks, deciding

between two strategies, cut prices or increase
advertising. Each knows the payoffs from each pair of
strategies
The prisoners’ dilemma
• Can you construct a prisoners’ dilemma matrix to show
how they both decide to cut prices although the optimal
outcome would result from both increasing advertising?
• Use the numbers 2, 4, 8 and 12 to represent payoffs in
millions of pounds. You’ll need to use each number twice
to construct a symmetrical matrix
Debs
Cut Ad
Cut 4 4 12 2
Marks
Ad 2 12 8 8
Nash equilibrium
• Nash equilibrium
– “A Nash equilibrium is a set of
strategies, one for each player,
such that each player is choosing
the best strategy, given the other
strategies of the other players. It
is an equilibrium because no
player could obtain a better pay-
off by adopting an alternative
strategy, given the strategies of
the other players.” (DD309, p.38)

• Is there a Nash equilibrium in the

P.D game?
• There is a Nash equilibrium, but it
produces a suboptimal outcome

John Nash
 A simultaneous game without
the dilemma
• Now let’s think about a different set of payoffs for the same game.
Assume both players still have the same dominant strategy, and
construct a matrix in which the Nash equilibrium is the optimal
outcome
• Again, use the numbers 2, 4, 8 and 12 to represent payoffs in
millions of pounds. Again, you’ll need to use each number twice to
construct a symmetrical matrix
Debs
Cut Ad
Cut 8 8 12 2
Marks
Ad 2 12 4 4
What if one player moves first?
Sequential games
• Now let’s go back to the P.D. but change the rules of the
game. This time, Marks makes the first move and Debs
decides how to react. The payoffs are unchanged

Cut
4 4
Cut D
Ad
12 2
M Cut
2 12
Ad D
Ad
8 8
Game theory poll 3: a sequential
game
• Do you think the outcome will be different from the
simultaneous game one?

Cut
4 4
Cut D
Ad
12 2
M Cut
2 12
Ad D
Ad
8 8
Finding the answer: subgames

(DD309, p 279)
Game theory poll 4: how many
subgames?

• How many subgames do you think there are in the

• extensive form P.D. Game?
Finding the answer: subgames
• How many?

Subgame III (The whole game)

Cut
4 4
Cut D Subgame I
Ad
12 2
M Cut
2 12
Ad D Subgame II
Ad
8 8
Finding the answer:
backwards induction
What’s the outcome? We need ‘backwards induction’

Subgame III (The whole game)

M prefers ‘Cut to ‘Ad’ (4>2)

Cut
4 4
Cut D Subgame I
Ad D prefers
12 2 ‘Cut’ to ‘Ad’
Cut (4>2)
M 2 12
Ad D Subgame II
Ad 8 8 D prefers
‘Cut’ to ‘Ad’
(12>8)
The answer

• It makes no difference to the outcome in this game

whether it is played simultaneously or sequentially
A different game
• Let’s consider a different game
• Both Marks and Debs are considering taking over a
competitor (a different one for each firm)
• Here is the matrix for the simultaneous game
• Is there a Nash equilibrium? Yes/No

Debs
Take Don’t
Take 3 3 6 4
Marks
Don’t 4 6 5 5
Solving the simultaneous game
• Actually, there are two Nash equilibria
• Either is a possible outcome, but each prefers another
(non-equilibrium) outcome to their less preferred
equilibrium
• So the outcome is indeterminate

Debs
Take Don’t
Take 3 3 6 4
Marks
Don’t 4 6 5 5
What if we make it sequential?
Let Debs move first

Subgame III (The whole game)

D prefers ‘Take’ to ‘Don’t’ (6>4)

Take
3 3
Take M Subgame I
Don’t M prefers
6 4 ‘Don’t’ to ‘Take’
Take (4>3)
D 6
4
Don’t M Subgame II
Don’t 5 5 M prefers
‘Take’ to ‘Don’t’
(6>5)
So we can see that re-casting a
one-shot game as sequential can
sometimes influence the outcome
Repeated games
• All the above examples, both simultaneous and
sequential, are single, or ‘one-shot’ games, played only
once.

• If a game is repeated (played more than once), there

can be different outcomes.

• The outcome will depend on

– How many times the game is repeated
– How the players react to the outcomes
Summary of game theory

• Concepts included:
– Simultaneous game
– Dominant strategy
– Nash equilibrium
– Sequential game
– Backwards induction
– Repeated games