Go, change the world

GAME THEORY(18CS7F2)
7th Semester,
CSE department
Faculty: Anitha Sandeep

UNIT-3
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Contents
• Extensive Games
Extensive games with perfect information
Strategies and outcomes
Nash equilibrium
Subgame perfect equilibrium
Finding subgame perfect equilibria of finite horizon games:
Backward induction
 Illustrations:The ultimatum game, Stackelberg’s model of duopoly
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Non cooperative games classification

Non cooperative games

Strategic games Extensive games

with ordinal with vNM with perfect info. With imperfect info.
preferences preferences

In this unit, we study extensive games with perfect information.

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• The model of strategic game suppresses the sequential structure of

decision making. When playing the model to situation in which
decision-makers move sequentially, we assume that each decision
maker chooses her action once and for all; she is committed to this
plan, which she cannot modify as events unfold. The model of
extensive game, by contrast, describes the sequential structure of
decision making explicitly, allowing us to study situations in which
each decision maker is free to change her mind as events unfold.
• Here decision maker is fully informed about all previous actions.
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Extensive games with perfect information

In extensive games, when a player takes the decision he observes the
decision taken by the other player and then he makes the move. He is
not committing anything in the beginning. The game is unfolding in a
sequential manner. Everybody looks into actions taken by other player
before he takes an action. Therefore things are known.
Ex: Chess
To represent extensive game with perfect information, we need to
specify set of player, their preferences as in strategic game. In
addition, we need to specify the order of the players’ moves and the
actions each player may take at each point. This is done by specifying
the set of all sequences of actions that can possibly occur, together
with player who moves at each point in each sequence. We refer to
each possible sequence of actions as a terminal history and to the
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function that gives the player who moves at each point in each terminal
history as the player function.
Defn: Extensive game with perfect information has 4 components:
• Players
• Terminal histories – are specified as a set of sequences. But not every
sequence is a legitimate set of terminal histories and no sequence is a
proper sub history of any other sequence.
• Player function – tells whose turn it is after every sequence that is a
proper sub history of some terminal history. That is it tells who has to
play after some sequence which is a proper sub history of terminal
history. It assigns a player to every sequence that is a proper
subhistory of some non terminal history
• Preferences – for each player preferences over set of terminal
histories is specified by payoff function.
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Entry Game
• Players – Challenger(player1), Incumbent(player2)
• Terminal histories – (Out), (In, Fight), (In, Accommodate)
• Player function is defined for all proper sub histories.
P(ɸ) = Challenger/player1
P(In) = Incumbent/player2
• Preferences-
For player1: U1(In, Accommodate) > U1(Out) > U1(In, fight)
For player2: U2(Out)> U2(In, Accommodate) > U2(In, fight)
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Entry game: Game Tree 1

In Out
2
Accomodate fight (1,2)

(2,1) (0,0)
Action set of a player i: Ai(h) = {a | (h, a) is a history}
Finite horizon game: If length of longest terminal history is finite, then
the game is called finite horizon game.
Finite game: If the game has a finite horizon and finitely many terminal
histories, we say the game is finite.
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1. Represent extensive game with perfect information in which terminal

histories are (C,E),(C,F),(D,G) & (D,H) , the player function is given by
P(ɸ) = 1, P(C) = P(D) =2, player1 prefers (C,F) to (D,G) to (C,E) to (D,H)
and player2 prefers (D,G) to (C,F) to (D,H) to (C,E).
Soln: 1
C D
2 2
E F G H
(2,1) (4,3) (3,4) (1,2)
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2. For the following game, write set of players, terminal histories, player
function and preferences:
1
2 C D
1 E F (2,0)
G H (3,1)
(1,2) (0,0)
Ans: Players – 1 and 2
Terminal histories – (D), (C,F), (C,E,G) and (C,E,H)
Player function: P(ɸ) = 1, P(C)=2 , P(C,E) =1
Preferences: Player1 prefers (C,F) to (D) to (C,E,G) to (C,E,H)
Player2 prefers (C,E,G) to (C,F) to (D) = (C,E,H)
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Solution of an Extensive Game

In the entry game, it seems that the challenger will enter and the
incumbent will subsequently accommodate. The challenger can reason
that if it enters then the incumbent will accommodate, because doing
so is better for incumbent than fighting. Given that the incumbent will
respond to entry in this way the challenger is better off entering.
This line of argument is called
backward induction.
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Solution of an Extensive Game

• Backward induction is the process of reasoning backwards in time,
from the end of a problem or situation, to determine a sequence of
optimal actions. It proceeds by first considering the last time a
decision might be made and choosing what to do in any situation at
that time.
• Backward induction in game theory is an iterative process of
reasoning backward in time, from the end of a problem or situation,
to solve finite extensive form and sequential games, and infer a
sequence of optimal actions.
• In backward induction, the player who is not making the last move
puts himself in the shoes of the last mover and see what is the
optimal decision for last mover. And by figuring out, he goes
backwards and then he calculates what is his optimal action.
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• At each stage of the game backward induction determines the

optimal strategy of the player who makes the last move in the game.
Then, the optimal action of the next-to-last moving player is
determined, taking the last player's action as given. This process
continues backward until the best action for every point in time has
been determined. Effectively, one is determining the Nash equilibrium
 of each subgame of the original game.
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Solving Sequential Games Using Backward Induction
1. Entry game: Game Tree 1
In Out
2
accom fight (1,2)

(2,1) (0,0)
Here player2 plays last if player1 enters In. For player2, it is better to
select accommodate rather than fight since 1>0.
Nor for player1, if he enters In, he knows that he will get payoff of 2
and if he goes out he will get a payoff of 1. Therefore player1 selects
In.
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Solving Sequential/Extensive Games Using

Backward Induction
Ex-2
Here, last player is player2. He want
to maximize his pay off(rational)
So, between up and down, he select
Up which gives him more payoff if
Player1 has played left;
Similarly between up and down, he select Up which gives him more
payoff if Player1 has played right;
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Now player1 knows that player2 will play up whether he play left or
right. So, he has to decide whether he has to play left or right. If he
plays left, he will get payoff of 1 and if he plays right he will get payoff
of 4. So, player1 plays right. So, NE is player1 plays right and player2
plays up. (Right, Up) is solution.
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Limitations of Backward Induction

1. If payoffs are same- because he can’t predict what will be the move
by other player.
2. If game is infinite horizon game ie, if longest terminal history goes
to ∞- here also there is no final stage and there is no final stage,
how can we go backward, where to start?
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Strategy:
A player strategy specifies the action the player chooses for every
history after which it is her/his turn to move.
Definition: A strategy of a player i in an extensive game with perfect
information is a function that assigns to each history h after which it is
player i’s turn to move an action in Ai(h){action set after history h, h is
proper sub history of some terminal history}
Ex: 1. For entry game, strategy of player1 are {in, out} and for player2
strategies are {accommodate, fight}
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Ex-2 1 Strategies
x1 x2 Player1: S1= {x1,x2}
2 2 Player2: S2={y1a1, y1a2, y2a1, y2a2}
y1 y2 a1 a2

Ex-3 1 Strategies
x1 x2 Player1: S1={x1z1,x1z2,x2z1,x2z2}
2 2 Player2: S2={y1a1, y1a2, y2a1, y2a2}
y1 y2 a1 a2
1
z1 z2
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Exercise: 156.2 (c) page 157
Represent the following as an extensive form game tree.
Description: Politicians Rosa and Ernesto have to choose either
Berlin(B) or Havana(H) as the location for party. They choose
sequentially. A third person Karl, determines who chooses first. Both
Rosa and Ernesto care only about their actions they choose, not about
who chooses first. Rosa prefers the outcome in which both she and
Ernesto choose B to that in which they both choose H, and prefers this
outcome to either of the ones in which she and Ernesto choose
different actions; she is indifferent between these last two outcomes.
Ernesto’s preferences differ from Rosa’s in that the role of B and H are
reversed. Karl preferences are same as Ernesto’s. Model this as an
extensive game with perfect information.
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• Exercise: 177.2 page 177

(The “rotten kid theorem”) A child’s action a affects both her own
private income c(a) and her parent’s income p(a); for all values of a we
have c(a) < p(a). The child is selfish: she cares only about the amount of
money she has. Her loving parent cares both about how much money
she has and how much her child has. Specifically, the preferences of the
child are represented by a payoff function Uc equals to the smaller of
the amount of money she has and the amount of money her child has.
The parent may transfer money to the child. This transfer is denoted by
t ≥ 0. In that case, the utility Uc of the child is given by: Uc(a, t) = c(a) + t
whereas the utility of the parent is: Up(a, t) = min {p(a) − t , c(a) + t} The
timing is as follows. First the child takes an action, then the parent
decides how much money to transfer. Model this situation as an
extensive game.
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Soln:
• Players: The parent and the child.
• Terminal histories: The set of sequences (a, t),
where a is an action of the child and t is a transfer
from the parents to the child;
a and t are positive numbers.
• Players’ function: P(∅) is the child, P(a) is the
parents for each value of a.
• Preferences: For the child is given by: Uc(a, t) = c(a) + t
For the parent, Up(a, t) = min {p(a) − t , c(a) + t}
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Exercise:
Represent the following as an extensive form game tree.
Description: Anna is thinking about buying a pencil from Bob. Anna’s
value for pencil is 1.5. Bob posts the price either 0,1 or 2 and then Anna
decides whether to accept or reject the offer.
a) Model this as an extensive game with perfect information
b) Convert to strategic game and find NE
c) Find SPE.
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Strategy Profile
It is like an action profile. It is a collection of different strategies of
different players.
Strategy profile s=(s1,s2,……sn) where si is the strategy of ith player.
A strategy profile s traces a terminal history. This is called outcome of
strategy profile, represented as O(s).
Ui(O(s)) is the payoff of ith player to the outcome of a strategy profile.
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Nash Equilibrium
A strategy profile s* is a NE if for every player i and every strategy si of
player i, the terminal history O(s*) generated by s* is at least as good
according to i’s preferences as the terminal history O(si, s*-i) generated
by the strategy profile (si, s*-i) in which player i choses si while every
other player j choses sj*.
ie, ui(O(s*)) ≥ ui(O(si, s*-i)) for every strategy si of player i.
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Transforming Extensive game to strategic

game
Players(strategic game)- players in extensive game
Actions- each players set of actions is her set of strategies in extensive
game
Preferences - each players payoff to each action profile sis here payoff
to terminal history generated by that action profile in the extensive
game
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Ex:1
For entry game, 1 S1={In,Out}
In Out S2={Accom,Fight}
2 (1,2)
Accom Fight
(2,1) (0,0)
Players – 1,2
Actions – A1=S1={In, Out}, A2 = S2 ={Accom, Fight} 1/2 Accom Fight
Preferences – are given by game table as below: In (2*, 1'') (0, 0)

Out (1, 2'') (1*, 2'')

NE – (In,Accom) and (Out,Fight)
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Ex-2 1 Strategies
x1 x2 Player1: S1= {x1,x2}
2 2 Player2: S2={y1a1,y1a2, y2a1,y2a2}
y1 y2 a1 a2

(1,0) (3,2) (2,3) (0,1)

Players-1,2
Actions: A1=S1= {x1,x2} A2=S2={y1a1, y1a2, y2a1, y2a2}
1/2 y1a1 y1a2 y2a1 y2a2
Preferences : are given in following game table
x1 (1,0) (1*,0) (3*,2') (3*,2')

x2 (2*,3') (0,1) (2,3') (0,1)

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Ex-3 1 Strategies
x1 x2 Player1: S1={x1z1,x1z2,x2z1,x2z2}
2 (2,0) Player2: S2={y1, y2}
y1 y2
1
z1 z2 (3,2)
(1,2) (0,0) 1/2 y1 y2

Equivalent strategic game is : x1z1 (1,2') (3*,2')

Playes – 1,2 x1z2 (0,0) (3*,2')

Actions : A1=S1={x1z1,x1z2,x2z1,x2z2} x2z1 (2*,0') (2,0')

A2=S2={y1, y2} x2z2 (2*,0') (2,0')

Preferences are given by game table:
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• Ex-4
Find NE by converting the game into
Strategic game.
Ans: NE:{ (L,ad), (R,ac) ,(R,bc)}

Robust NE is (R,ac)

P1/P2 ac ad bc bd

L (0,10*) (0’,10*) (-3,2) (-3’,2)

R (3’,1*) (-6,-2) (3’,1*) (-6,-2)

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To prove that (x1z1, y2) is a NE 1/2 y1 y2

x1z1 (1,2') (3*,2')
Here player1 plays x1 after empty history and
x1z2 (0,0) (3*,2')
Will play z1 after history y2. Player1 gets payoff of
x2z1 (2*,0') (2,0')
3 and player2 gets a payoff of 2( payoff is(3,2))
x2z2 (2*,0') (2,0')
If player2 deviates to y1, then he gets 1<3. So
Player2 is not improving his payoff. So there is no point for player2 to
deviate.
If player1 deviates and chooses x2, then given other actions specified by
this strategy profile, we reach terminal history x2. Therefore player1 get
2 <3. Therefore there is no point for player1 to deviate after empty
history. Other deviation is at z1. If he chooses z2, then his payoff will be
0<3. Therefore there is no point for player1 to deviate.
Hence (x1z1, y2) is a NE.
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Robust NE :
Introduction:
When agents or decision maker have uncertainties of underlying
parameters, they may want to take “robust” decisions that are optimal
against the worst possible values of those parameters, leading to some
max-min optimization problems. With several agents in competition, in
game theory, uncertainties are even more important and robust games
have gained a lot of interest recently, notably in auctions.
Robust strategies of players maximize the worst possible payoff
compatible with their information; this is also called their maxmin
utility.
An equilibria which survive if simultaneous play assumption is relaxed is
called Robust NE.
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Robust NE :
A NE strategy is said to be robust if when one of the player deviates,
then the remaining strategy which is mentioned in the equilibrium
strategy is still the best for the other player.
1/2 Accom Fight
Ex: In Entry game,
In (2*, 1'') (0, 0)
(Out, Fight) is NE. but it is
not robust. Because, Out (1, 2'') (1*, 2'')

If player1 deviates then fight is best action and also player is not
observing fight.
But in (In, Accomm), there is no such problem.
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To check NE for robustness

Here player1 plays x1 and player2
plays y2 after history x1 and plays a2
after the history x2. The payoff for
terminal history reached is (3,2).
When player1 plays x1, y2 is best response to player2.
Suppose player1 deviates to x2, then for player2, y2a2 is not the optimal
1/2 y1a1 y1a2 y2a1 y2a2
strategy. So NE is not robust.
x1 (1,0) (1*,0) (3*,2') (3*,2')

x2 (2*,3') (0,1) (2,3') (0,1)

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To check NEfor robustness
NE robust.
Here player1 plays x1 and player2
plays y2 after history x1 and plays a1
after the history x2. The payoff for
terminal history reached is (2,3).
When player1 plays x2, a1 is the best response.
Suppose player1 deviates to x1, then y1a1 is not optimal strategy for
player2. So for player2, the strategy y1a1 is not the best.
So NE is not robust.
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To check NE for robustness
But NE robust.
Here player1 plays x1 and player2
plays y2 after history x1 and plays a1
after the history x2. The payoff for
terminal history reached is (3,2).
When player1 plays x1, y2 is best response to player2.
Suppose player1 deviates to x2, then y2a1 is best strategy to player2.
Suppose player2 deviates after history x2 to a2. Then still for player1, x1
which is the action in NE is best response.
So NE is robust.
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Sub game Perfect NE(SPE/SPNE)

Sub game of a game: Let ꞇ be an extensive game with perfect
information with player function P. For any non terminal history h of ꞇ,
the subgame ꞇ(h) following the history h is the following extensive game.
• Players – Players in ꞇ
• Terminal histories - The set of all sequences h’ of actions such that
(h, h’) is a terminal history.
• Player function – The player function P(h,h’) is assigned to each proper
sub history h’ of a terminal history.
• Preferences – Each player prefers h’ to h’’ iff she prefers (h, h’) to
(h, h’’) in ꞇ.
NOTE: The sub game following empty history Φ is the entire game itself.
All other sub games are called proper sub games.
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SPNE/SPE
SPE is also a strategic profile. But the specialty is that this strategy profile should
be such that it generates equilibrium in every possible sub game. In particular
also in sub games which are not included in the terminal histories generated by
strategy profiles.
Informally, this means that if the players played any smaller game that consisted
of only one part of the larger game, their behavior would represent a Nash
equilibrium of that smaller game. Every finite extensive game with perfect recall
has a subgame perfect equilibrium.
Ex: In Entry game, the strategy profiles (In, Accom) and (Out, Fight) are NE.
But only (In, Accom) is SPE, Here terminal history generated is (In, Accom). If
player1 chooses Out, then also Accommodate is best response for player2,
where as for (Out, Fight), Here terminal history generated is (Out).
if player1 chooses In, then Fight is not best response for player2.
(Out, Fight) is not SPNE, only (In, Accom) is SPE.
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SPNE/SPE Definition
1.For every player i and every history h after which it is the player i’s
turn to move, ui(Oh(s*))≥ ui(Oh(si,s-i*)) for every strategy si of player i.
Here Oh(s) is the terminal history consisting of h followed by sequence
of actions generated by s after h.
2. SPE induces equilibrium in each possible sub game of the entire
game. For every player i, and every non terminal history h after which i
is to make a move, ui(Oh(s*))≥ ui(Oh(si,s-i*)) for every strategy si of player
i.
NOTE: for any strategy profile s, OΦ(s) = O(s)
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Steps for finding SPE

Let l be the length of longest terminal history of game.
1. Start with sub game of length 1. Find optimal actions for the players
who are in beginning of sub game.
2. Then take sub game of length 2. Find optimal actions for the players
who are in beginning of sub game.
3. Repeat …. Until you reach beginning of game(or subgame of length l)
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Problems on finding SPE
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Problems on finding SPE

1. Find SPE of following game.
Soln: Consider subgame of length=1
a) Here h=D,L and player1 plays.
p is the best action for player1
b) Here h=U and player2 plays.
T is the best action for player2
Consider sub game of length=2
Here h=D and player2 plays. L is the best action for player2
Consider sub game of length=3
Here h=ɸ and player1 plays. D is the best action for player1.
Therefore SPE = (Dp,LT)
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2. Find SPNE of following game:

Ans: (Lac, r1I2)

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3. Find SPNE of following game:

Ans: (OutOB, B)

4. Find SPNE of following game:

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5. Find NE of following extensive game by converting to strategic game.

Also find SPNE.
Ans:
NE: { (L,ad),(R,bc),(R,ac)}
SPE: (R,ac)
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Ex: 173.4 Page 173 Burning a bridge

Army1 of country1 must decide whether to attack army2 of country2,
which is occupying an island between the two countries. In the event
of an attack, army2 may fight or retreat over a bridge to its mainland.
Each army prefers to occupy it; a fight is the worst outcome for both
armies. Model this situation as an extensive game with perfect
information an show that the army2 can increase its sub game perfect
equilibrium payoff(& reduce army1’s payoff) by burning bridge to its
mainland, eliminating its option to retreat if attacked.
Soln: Model: …………..
SPE: (attack, retreat)
Equilibrium payoff = (2,1) here army1’s
Payoff is 2 and army2’s payoff is 1.
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• If retreat option is eliminated, then the game tree will be as below:

Here, SPE= (not attack, fight) and payoff

at this SPE is (1,2). That is army1’s payoff
is 1 and army2’s payoff is 2. Therefore
army1’s payoff is reduced and army2’s
payoff is increased.
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Games when payoff function is continuous

1. Synergic relationship game
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u1= a1( c+a2-a1)

u2= a2( c+a1-a2)
Consider sub game of length 1
Here h=a1 and player 2 plays
Player2 maximizes his profit.

 ⇒ a2(-1)+(c+a1-a2).1=-2a2+c+a1=0 (u1,u2)

∴ a2=½ (c +a1)
Now consider sub game of length 2
u1= a1( c+a2-a1) = a1 ( c+½ (c +a1)-a1) = ½a1(3c-a1)
Here player1 plays and he maximizes his profit.
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u1= a1( c+a2-a1) = a1(c+½ (c +a1)-a1) = a1(c+½ c + ½ a1 –a1)

= a1(c+½ c + ½ a1 –a1) = a1( c – a1)= ½a1(3c-a1)

(½a1(3c-a1))=0
⇒ ½a1(-1) +(3c-a1) ½=0
⇒ a1*=c
∴ a2=½ (c +a1) becomes a2*=c
So a1*=c and a2*=c are equilibrium outcomes.
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2. Firm-Union Bargaining
Description: A union and a firm are bargaining. First, the union presents
a wage demand w ≥ 0. The firm can accept or reject this w. If the firm
chooses accepts, then the firm chooses an amount L ≥ 0 of labor to
hire. The firm’s output is L(100 − L) when it uses L ≤ 50 units of labor,
and 2500 if L > 50. The price of output is 1. If firm rejects demand, no
production takes place(L=0). The firm’s preferences are represented by
its profits. The union’s preferences are represented by the total wage
bill, wL.
a) Model this as an extensive game with perfect information.
b) Find SPE of game.
c) Find payoff to firm and union at SPE
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Firm-Union Bargaining
Soln:
• Players: The union and the firm.
• Terminal histories: The set of sequences (w, L),
where w is the wage demand offered by union
reject
and L is units of labor the firm uses.
• Players’ function: P(∅) is the union,
P(w) is the firm
• Preferences:
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Firm-Union Bargaining
For every w ≥ 0, there is a subgame where
the firm’s payoff depends on w.
Profit has a quadratic part (if L ≤ 50) and
a linear part (if L > 50), and is continuous at L = 50.
reject
We want to find the profit-maximizing choice of L.
The linear part is decreasing in L, so we can ignore
it (its maximum is at L = 50).
Quadratic part is maximized at L = .
Firm’s profit is: (100 − ) − w =
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• Now, consider the union’s decision.

If w = 0 or w > 100, union’s payoff is 0.
wBf(w) =w () is maximized at w∗ = 50.
L∗ = Bf(50) = 25.
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The set of subgame perfect NE is:

Union’s strategy profile: at the empty history, choose w = 50.
Firm’s strategy profile: at the subgame following the history w, choose an
element of Bf(w).
Note that the firm has an infinite number of strategy profiles, but there is
only one equilibrium outcome, since only the subgame after w = 50 will be
realized.
At SPE, Firm’s payoff = = = 625
union’s payoff = wL=w*L* = 50x25=1250.
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3. Ultimatum game
Description: Two players want to divide some amount of money c. In
the first round, player1 proposes a division of money x to be given to
player2. In the next round player2 has 2 choices either to accept(Y) or
to reject(N). If player2 accepts, both get amount. If he rejects both get
0.
Model:
Here player1 has ∞ number of actions. And player2 has a weapon to
threaten by rejecting offer.
• Players – 1and 2
• Terminal history- sequences of the form (x,z) where 0 ≤ x ≤ c and
Z=Y/N
• Player function- P(ɸ)=1, P(x)=2
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• Preferences- are represented by payoffs that players are getting at the end
of the game.
U1(x, Y) = c-x U2(x, Y) = x U1(x, N) = 0 = U2(x, N)
The game tree is as below.
To find SPE
Consider sub game of length=1
Here player2 plays and he chooses Y if x>0
If x=0, player2 is indifferent between Y ,N
So, player2 has 2 optimal strategies.
a) Accept any offer with x≥ 0
b) Accept any offer with x>0 and reject if x=0
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Consider sub game of length=2

Here player1 plays.
Player1 can offer x=0 or x>0
Wrt a, player1’s optimal strategy is to offer x=0
Wrt b, player1 does not have any optimal strategy since x is continuous.
Therefore SPE is player1 offers x≥0 and player2 accepts the offer
ie SPE = (offer x=0, Accept any offer with x≥ 0) and equilibrium payoffs
are c and 0.
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Variants of Ultimatum game

1. If amount of money available is in multiple of a cent.
Soln: Here c is available in multiple of a cent(paise)
Here there are 2 SPE
a) (offer x=0, Accept any offer with x≥0)
b) (offer x=1, Accept any offer with x>0, reject if x=0)
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2. Dictator game - Here person2 has no option

to reject.

3. Impunity game - Here when person2 rejects, 1

then person1’s payoff is c-x, rather than 0.
Here player2 is unable to punish player1 for
making low offer.
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4. Holdup game – Here there are 3 stages : 2 -> 1-> 2

In stage1, player2 puts effort E=Low(L) or High(H)
If E=H, then ∏= High ⇒ both will share large ∏ = CH
If E=L, then ∏= Low ⇒ both will share small ∏ = CL
The game tree is as below.
Model:
• Players - 1,2
• Terminal history- (E, x, z) where E=L or H
x∈ [0,CL] if E=L and x∈ [0,CH] if E=H
Z= Y or N
• Player function - P(ɸ)=2, P(E)=1,
P(E, x)=2, ∀x
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• Preferences - U1(E, x, N) = 0 U1(L, x, Y) = CL-x U1(H, x, Y) = CH-x

U2(L, x, N) = -L U2(H, x, N) = -H U2(L, x, Y) = x-L U2(H, x, Y) = x-H
To find SPE
In subgame of length 2, player2 is playing. He will either get –L or –H in
equilibria. ∵ -L>-H, player2 chooses L rather than H.
∴ SPE is (L, offer x=0, Accept any offer x≥0)
∴ equilibrium payoffs are (CL, L) and this equilibrium is not efficient.
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4. Stackleberg model of Duopoly

Model:
• Players- Two firms 1, 2
• Terminal histories – Sequences of form (q1,q2) where qi is any non
negative number.
• Player function – P(ɸ) = 1, P(q1)=2
• Preferences – Ui= qi Pd(q1+q2) – ci qi where Pd is inverse demand
function which gives price per unit during selling.
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Game tree is as below

Let q2* is unique for every q1 which
maximizes payoff of player2.
In sub game of length 2, player1
maximizes his payoff
U1(q1,q2)= U1(q1,b2(q1))
∴ (q1*,b2(q1*)) is terminal history in SPE.
Constant unit cost and Linear inverse demand function
Here Pd= α – Q, if Q ≤ α
Pd = 0 , if Q > α and
Ci(qi)= c qi , c>0 , α > c> 0
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∏2=q2 Pd(q1+q2)-cq2 = q2(α –q1-q2) – cq2 = q2(α - q1-q2 - c)

∏1=q1 Pd(q1+q2)-cq1= q1(α –q1-q2) – cq1 = q1(α - q1-q2 - c)
Given q1, firm2 wants to max ∏2(q1,q2) subject to q2.
∴ best response function of firm2 is given by,
q2=b2(q1)= ½ (α – q1- c) if q1 ≤ α – c
=0 if q1 > α – c
At the beginning firm1 maximizes ∏1(q1,q2) subject to q1
=max wrt q1, ∏1(q1 ,b2(q1)) wrt q1
=max wrt q1, q1(α - q1- ½ (α – q1- c) - c) = q1(½ (α – q1- c))
From first order condition, we get q1*= (α - c)/2
Given q2*=b2(q1) = (½ (α – c - (α - c)/2 ) = (α - c)/4
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Centipede game
• The centipede game is an extensive-form game in game theory in
which two players alternately get a chance to take the larger share of
a slowly increasing money stash. ... “Centipede game” is so-called
because its original version consisted of a 100-move sequence.
• There are 2 players-player1 and player2. Each player starts with ₹1.
They alternate saying ‘stop’ or ‘continue’ starting with player1. when
a player says ‘continue’, ₹1 is taken by refree from his pile and ₹2 are
put in other players pile. As soon as either player says ‘stop’ game is
terminated and each player receives money currently in her pile.
Alternatively the game stops if both players piles reach ₹100. Model
game and find SPE.
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Soln :
The game tree is as below:

SPE : Unique SPE saying S at each sub game for both players.
Terminal history reached by SPE is (S). Equilibrium payoff is (1,1)
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Voting by alternating veto

Description: Two people select a policy that affects them by
alternatively vetoing(refusing) policies until only remains. First the
person1 vetoes a policy. If more than one policy remains, person2
then vetoes a policy. This repeats until single policy remains. Suppose
there are 3 policies X,Y,Z. Person1 prefers X to Y to Z and person2
prefers Z to Y to X. Model this as an extensive game and find NE and
SPE.
Soln:
• Players- 1,2
• Player function: P(ɸ)= 1 , P(X)=P(Y)=P(Z)=2
• Preferences are given in game tree as below:
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Terminal histories : (X,Y), (X,Z), (Y,X),(Y,Z),

(Z,X),(Z,Y)
Converting this to strategic game and
Solving we get NE = (Z,YXX) and (Z,ZXX)
SPE=(Z,YXX)