Static Games of Complete Information

GAMES
EQUILIBRIUM CONCEPTS
THE TRAGEDY OF THE COMMONS
MULTIPLE NASH EQUILIBRIA
NASH THEOREM
3. Lectures on
STATIC GAMES OF COMPLETE
INFORMATION
Luigi Buzzacchi
e-mail: luigi.buzzacchi@polito.it
Politecnico di Torino
DIST
A.A. 2013/14
v. 30 03 14 Static games of complete information
GAMES
NASH THEOREM
Outline of the chapter
1
GAMES
Normal-form representation of games
2
Elimination of strictly dominated strategies
Iterated elimination of strictly dominated strategies
Nash equilibrium
3
4
Mixed strategies
5
NASH THEOREM
GAMES
NASH THEOREM
Denitions /1
Game theory is a set of tools that is used to model the behaviour or
choices of players (consumers, rms, etc.) when the payoff (prot) of a
choice depends on the choice of other players. Recognized payoff
interdependency gives rise to interdependent decision making or
strategic interaction
The optimal choice of a player will depend on her expectation of the
choices of others playing the same game. How expectations of every
player are formed?
GAMES
NASH THEOREM
Denitions /2
Our game-theoretic analysis builts on three fundamental assumptions:
1
Rationality. We assume that a players preferences can be represented
by a utility function or payoff function. Game theory assumes that
players are interested in maximizing their payoffs. A utility function
simply assigns an index number to each outcome with the property that
higher index numbers are assigned to outcomes that are more preferred.
In game theory it is common to refer to a players utility function as her
payoff function. Payoffs for rms are simply prots or expected prots
2
Common information. Every player knows i) the structure of the
game and ii) that his opponents are rational. This information is
common knowledge. An information is commonly known when all of
the players know that information; moreover, they know that their
opponents know that they know that information; moreover, they know
that their opponents know that they know that their opponents know
. . . , and so on
3
Non-cooperation. Players are unable to sign credible contracts before
the beginning of the game
GAMES
NASH THEOREM
Normal-form representation of games /1
The normal form specication of a game species:
1
the number (n) of the players in the game
2
the set of (pure) strategies (S
i
) available to each player; a strategy is
identied by s
i
S
i
(i = 1 . . . n). Actions and strategies coincide only in
static games of complete information
3
a payoff function (u
i
= u
i
(s)) for each player. Such function assigns each
player i a level of utility for each prole/combination of strategies s,
s S
1
S
2
. . . S
n
The normal form representation of a game is consequently:
G = {S
1
. . . S
n
; u
1
. . . u
n
}
GAMES
NASH THEOREM
Normal-form representation of games /2
In a static game players choose their strategies simultaneously.
Simultaneously means that none of the players can benet of the
information concerning the choice of the rivals (logical vs.
chronological simultaneity)
An equilibrium concept is a function that associates to a game a
specic combination of strategies
: G {s
1
. . . s
n
}
The combination selected by the function is the one which is
composed by strategies that make the correspondent player satised
What is satisfaction?
GAMES
NASH THEOREM
Nash equilibrium
The prisoners dilemma /1
Player 2
Mum Fink
Player 1
Mum 1, 1 9, 0
Fink 0, 9 6, 6
Dominated strategy:
s
i
is dominated if s
i
| u
i
(s
i
, s
i
) > u
i
(s
i
, s
i
) s
i
Strict and weak dominance
GAMES
NASH THEOREM
Nash equilibrium
The prisoners dilemma /2
Mum is dominated by Fink: the combination of strategies {Fink; Fink}
solves the game
Solving a game means providing a forecast of the outcome (of the
equilibrium)
In general, we have a prisoners dilemma game when:
D(efection) > C(ooperation) > P(unishment) > S(uckers payoff)
Player 2
Mum Fink
Player 1
Mum C, C S, D
Fink D, S P, P
The free-riding problem can be interpreted as a prisoners dilemma
GAMES
NASH THEOREM
Nash equilibrium
Iterated elimination of strictly dominated strategies /1
In this game, several combinations of strategies are all composed by
non-dominated strategies
Player 2
Left Center Right
Player 1
Up 1, 0 1, 2 0, 1
Down 0, 3 0, 1 2, 0
Only Up, Center, however, survives to an iterative process of
elimination of dominated strategies
GAMES
NASH THEOREM
Nash equilibrium
Iterated elimination of strictly dominated strategies /2
Is that procedure a good representation of a rational choice? A rational
player never plays strictly dominated strategies. This equilibrium
concept need adequate assumptions concerning the rationality of the
opponent (common knowledge)
Despite the fact that iterated elimination of dominated strategies is a
less demanding concept, the largest part of conceivable games still
cannot be solved
Player 2
Left Center Right
Player 1
Left 0, 4 9, 0 5, 3
Center 4, 0 4, 4 5, 3
Right 3, 5 2, 5 6, 6
GAMES
NASH THEOREM
Nash equilibrium
Best responses and Nash equilibrium
A reaction function is a function dened in the strategy space as:
R
i
(s
i
) = argmax
s
i
[u
i
(s
i
, s
i
)]
A best response s
i
is a strategy which is a specic value of the reaction
function, i.e.
s
i
= R
i
(s
i
)
A strategically stable (self-enforcing) outcome is obtained when no
player has anything to gain by changing his own strategy unilaterally
A strategy combination is a Nash equilibrium if its outcome is
strategically stable
GAMES
NASH THEOREM
Nash equilibrium
Nash equilibrium
In the game G, the strategy combination s
N
= {s
N
1
. . . s
N
n
} is said to be a
Nash equilibrium if:
u
i
(s
N
i
, s
N
i
) u
i
(s
i
, s
N
i
) s
i
, i
This happens when s
N
i
solves the problem:
max
s
i
[u
i
(s
i
, s
N
i
)]
Player 2
Left Center Right
Player 1
Left 0, 4 9, 0 5, 3
Center 4, 0 4, 4 5, 3
Right 3, 5 2, 5 6, 6
Notice that every strategy is a best response to some strategy of the
rival. This is a sufcient (not necessary) condition for not having any
dominated strategy (see below)
GAMES
NASH THEOREM
Nash equilibrium
Equilibrium concepts hierarchy
Proposition A. In the normal form game G, if iterated elimination of
strictly dominated strategies eliminates all but one strategy for every
player, then the survived strategy combination is the unique Nash
equilibrium of the game.
Proposition B. In the normal form game G, every strategy combination
which is a Nash equilibrium survives iterated elimination of strictly
dominated strategies
An example of a Nash equilibrium that does not survive an iterated
elimination of weakly dominated strategies is the Prisoners Dilemma
where the {Mum; Mum} payoff is 0 for both players
GAMES
NASH THEOREM
The tragedy of the commons [Hardin, 1968] /1
It is a problem of public goods exploitation
n farmers own g
i
(i = 1 . . . n) animals which are grazed on the village
green
The cost per head of livestock is c
The revenue per head of livestock is:
v(
i
g
i
) v
< 0 [and v
< 0]
The strategic variable of the players is the number g
i
of animals they
(simultaneously) decide to breed
The individual farmers payoff is consequently:
u
i
(g
i
, g
i
) = g
i
v(g
i
+ g
i
) cg
i
GAMES
NASH THEOREM
The tragedy of the commons [Hardin, 1968] /2
The Nash equilibrium is dened by:
g
i
= argmax
g
i
[g
i
v(g
i
+ g
i
) cg
i
] i
FOCs are:
v(g
i
+ g
i
) + g
i
v
(g
i
+ g
i
) c = 0
or, equivalently
v(G
) +
G
(G
)
n
c = 0
The social optimum needs
G
= argmax
G
[Gv(G) cG]
whose FOC is
v(G
) + G
(G
) c = 0
It can be easily obtained that G
> G
This effect exemplies the so called free riding behaviour, which

emerges in presence of negative externalities (as is the exploitation of
public goods)
GAMES
NASH THEOREM
Mixed strategies
Battle of the sexes and matching pennies
Pat
Opera Fight
Chris
Opera 2, 1 0, 0
Fight 0, 0 1, 2
Battle of the sexes
Equal
Heads Tails
Different
Heads 1, 1 1, 1
Tails 1, 1 1, 1
Matching pennies
GAMES
NASH THEOREM
Mixed strategies
No unique equilibria and randomized actions
In both games the payoffs depend on the coordination of the actions of
the players. As they disagree about the preferred outcome, this type of
games are not characterized by unique equilibria
The behavior of the rival is consequently uncertain
We extend the analysis by admitting the possibility that the players
randomize their actions
A mixed strategy is a probability distribution:
{p
i1
. . . p
iK
} (
K
k=1
p
ik
= 1),
over the strategies in:
S
i
= {s
i1
. . . s
iK
}
GAMES
NASH THEOREM
Mixed strategies
Mixed strategies /1
The basic idea is that the concept of dominance has to be redened
once we admit mixed strategies
When s
i
is dominated, then no one (pure) strategy of the opponents s
i
(and consequently no one belief) can make s
i
a best response
It can be easily demonstrated that if s
i
is dominated, then not even a
mixed strategy of the opponents can make s
i
a best response
The opposite is false if we consider only pure strategies . . .
. . . but the opposite becomes true if we admit mixed strategies
In particular, . . . if there is no belief that player i could hold about s
i
such that it would be optimal to play s
i
, then there necessarily exists
a strategy s
i
(possibly mixed) that strictly dominates s
i
GAMES
NASH THEOREM
Mixed strategies
Mixed strategies /2
In the following game, B is never a best response for every pure
strategy played by 2, but neither T nor M dominate B. However, a
mixed strategy with p
T
=
1
2
and p
M
=
1
2
, strictly dominates the pure
strategy B (in expected value)
Player 2
L R
Player 1
T 3, 0,
M 0, 3,
B 1, 1,
The Nash equilibrium concept can be obviously extended when mixed
strategies are allowed
A pure strategy is only a particular mixed strategy
GAMES
NASH THEOREM
Mixed strategies
Best responses to mixed strategies
In a two players game with two symmetric actions {a, b}, if player 1
expects form player 2 a strategy {q, 1 q}, her payoff becomes:
E(u(a)) = qu(a, a) + (1 q)u(a, b)
and
E(u(b)) = qu(b, a) + (1 q)u(b, b)
Depending on q (the probability of a), the best response for player 1
could be a or b
In particular, the threshold q
,
q
=
u(b, b) u(a, b)
u(b, b) + u(a, a) u(a, b) u(b, a)
determines when the best response is a or the opposite (q q
). When
q = q
, player 1 is indifferent between a and b

GAMES
NASH THEOREM
Mixed strategies
Reaction functions for mixed strategies
In the case of a matching pennies game, for example, q
=
1
2
In a similar way player 2 can calculate her threshold r

GAMES
NASH THEOREM
Mixed strategies
Mixed strategies /3
More in general, in a two-player game, if p
1
and p
2
are the probability
distributions over the two set of actions of the players composed of J
and K elements, then:
v
1
(p
1
, p
2
) = E(u
1
(p
1
, p
2
)) =
J
j=1
K
k=1
p
1j
p
2k
u
1
(s
1j
, s
2k
)
v
2
(p
1
, p
2
) = E(u
2
(p
1
, p
2
)) =
J
j=1
K
k=1
p
1j
p
2k
u
2
(s
1j
, s
2k
)
. . . and the denition of Nash equilibrium becomes:
v
1
(p
1
, p
2
) v
1
(p
1
, p
2
)
v
2
(p
1
, p
2
) v
2
(p
1
, p
2
)
p
1
, p
2
GAMES
NASH THEOREM
Mixed strategies
Properties of mixed strategies equilibria
The condition for a mixed strategy p
1
to be the best response to the
mixed strategy p
2
, is that (from the FOC) p
1j
> 0 iif the pure strategy j
is also best response to p
2
, or equivalently:
K
k=1
p
2k
u
1
(s
1j
, s
2k
)
K
k=1
p
2k
u
1
(s
1j
, s
2k
) j
The interpretation of such property is the following. Expand v

1
as:
v
1
(p
1
, p
2
) = p
11
K
k=1
p
2k
u
1
(s
11
, s
2k
) + . . . + p
1J
K
k=1
p
2k
u
1
(s
1J
, s
2k
)
The weighted sum above obviously increases when we increase the
probability for pure strategies j that present a higher payoff
K
k=1
p
2k
u
1
(s
1j
, s
2k
) (at the same time decreasing the probabilities of
lower payoff strategies). The optimum is reached when only the
strategies with equal maximum expected payoff are randomized with
positive probability
GAMES
NASH THEOREM
Mixed strategies
Fundamental Lemma
At the equilibrium, each player is indifferent between the equilibrium
mixed strategy and every pure strategy played with positive probability
GAMES
NASH THEOREM
Mixed strategies
Example: controlling fare evasion
The game below illustrates the strategic interaction between a public
transport traveller (T) and the operator (O). P is the price of the ticket,
F is the ne and c is the cost of controlling, with F > T > c
O
Control No control
T
Buy ticket T, T c T, T p
Evade fare F, F c 0, 0 1 p
q 1 q
The expected payoff for T is pqT p(1 q)T (1 p)qF
The expected payoff for O is pq(T c) + p(1 q)T + (1 p)q(F c)
The Nash equilibrium is characterised by q
=
T
F
and p
=
F c
F
As F increases p
also increases, while q
decreases
As T increases q
also increases
As c increases p
decreases
GAMES
NASH THEOREM
Possible equilibria in a 2 2 static game
P2
L R
P1
U x, y,
D z, w,
x > z; y > w dominance

x < z; y < w dominance
x > z; y < w
x < z; y > w
If {r, 1 r} and {q, 1 q} are the generic strategies of P1 and P2
respectively; in the rst and in the second case r
= r(q) is a constant
(0 or 1); in the third and in the fourth cases the threshold q
=
wy
xz+wy
is the value where r
= 0 becomes r
= 1
In the equality cases (x = z and/or y = w), one of the strategies weakly
dominates the other one, so that the reaction function is L-shaped
(q
= 0 or q
= 1)
GAMES
NASH THEOREM
Nash theorem [1950]
Every couple of reaction function of the type illustrated above certainly
intersect in the r/q space within the square 0/1
In the sixteen possible cases, we can then obtain:
1
a unique NE in pure strategies
2
a unique NE in mixed strategies
3
two pure-strategy NE and one NE in mixed strategies
The Nash theorem generalizes such result when the number of players
and the number of strategy combinations are nite:
. . . if n and S
i
are nite i in G(S
1
. . . S
n
; u
1
. . . u
n
), then at least one
NE exists, possibly involving mixed strategies
Demonstration is based on the xed point theorem:
. . . if f (x) is continuous in [0, 1] x
f (x
) = x

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GAMES

This effect exemplies the so called free riding behaviour, which

, player 1 is indifferent between a and b

v. 30 03 14 Static games of complete information

The interpretation of such property is the following. Expand v

also increases, while q

x > z; y > w dominance

v. 30 03 14 Static games of complete information

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