Game Theory Sample Y Narahari

MSc Lecture Notes Series
Theory and
Game
Mechanism Design
Y Narahari
Indian Institute of Science, India
IISc
Press
World Scientific
NEW JERSEY
LONDON SINGAPORE BEIJING SHANGHAI HONG KONG TAIPEI CHENNAi
Contents
Dedication vii
Foreword ix
Opinions on the Book xi
About the Author xiii
Preface xv
Acronyms xxvii
Symbols and Notations xxix
1. Introduction and Overview 1
1.1 Game Theory: The Science of Strategic Interactions 1

1.2 Current Trends and Modern Applications 8
1.3 Outline of this Book 14
NON-COOPERATIVE GAME THEORY 17
2. Key Notions in Game Theory 19
2.1 Strategic Form Games 19

2.2 Preferences 20
2.3 Utilities 21
2.4 Rationality 21
2.5 Intelligence 23
2.6 Classification of Games 26
2.7 Summary and References 27
3. Extensive Form Games 31
3.1 Illustrative Examples 31
XXXlll
xxxiv Game Theory and Mechanism Design
3.2 Extensive Form Games: Definitions 34
3.3 Transforming Extensive Form to Strategic Form 37
3.5 Exercises 41
43
4. Strategic Form Games
4.1 Preliminaries 43
4.2 Pennies with Simultaneous Moves 44

Matching
4.3 Rock-Paper-Scissors Game 45
4.4 BOS (Bach or Stravinsky) Game 46
4.5 A Coordination Game 47
4.6 Prisoner's Dilemma Game 47
4.7 Company's Dilemma Game 48
4.8 A Non-Symmetric Company's Dilemma Game 49
4.9 A Duopoly Pricing Game 49
of the Commons 50
4.10 Tragedy
4.11 Bandwidth Sharing Game 51
4.12 A Sealed Bid Auction 51
4.13 Pigou's Network Game 52
4.14 Braess Paradox Game 53
4.16 Exercises 57
5. Dominant Strategy Equilibria 59
5.1 Strong Dominance 59
5.2 Weak Dominance 60
5.3 Very Weak Dominance 61

62
5.4 Illustrations of Dominant Strategy Equilibria
5.6 Exercises 65
6. Pure Strategy Nash Equilibria 67
6.1 The Notion of Nash Equilibrium 67
6.2 Illustrative Examples of Pure Strategy Nash Equilibrium 70
6.3 Games without a Pure Strategy Nash Equilibrium 74
6.4 Interpretations of Nash Equilibrium 76

78
6.5 Existence of Multiple Nash Equilibria
6.6 Maxmin Values and Minmax Values 79
6.7 Equilibria in Extensive Form Games 82
6.9 Exercises 87
Contents xxxv
7. Mixed Strategies and Mixed Strategy Nash Equilibrium 93
7.1 Mixed Strategies 93
7.2 Mixed Strategy Nash Equilibrium 95
7.3 Properties of Mixed Strategies 96
7.4 Necessary and Sufficient Conditions for a Profile to be a Mixed
Strategy Nash Equilibrium 98
7.5 Maxmin Values and Minmax Values in Mixed Strategies 104
7.6 Domination in Mixed Strategies 106
7.8 Exercises Ill
8. Utility Theory 115
8.1 Need for Utility Theory 115
8.2 Axioms of von Neumann -
Morgenstern Utility Theory 117
8.3 The von Neumann -
Morgenstern Theorem 121
8.4 Affine Transformations 123
8.5 Computing von Neumann -
Morgenstern Utilities 124
8.6 Risk Attitudes of Players 125
8.8 Exercises 129
9. Matrix Games 131
9.1 Examples of Matrix Games 132
9.2 Pure Strategies in Matrix Games 133
9.3 Saddle Points and Pure Strategy Nash Equilibria 135
9.4 Mixed Strategies in Matrix Games 137
9.5 Minimax Theorem 142
9.7 Exercises 147
10. Existence of Nash Equilibrium 149
10.1 Correspondences and Fixed Point Theorems 150
10.2 Nash Equilibrium as a Fixed Point 151
10.3 Sufficient Conditions for Existence of Pure Strategy Nash Equilibria 153
10.4 The Nash Theorem 154
10.5 Sperner's Lemma 156
10.6 Sperner's Lemma to Brouwer's Fixed Point Theorem 160
10.7 Proving Nash Theorem using Brouwer's Theorem 163
10.8 Existence of Nash Equilibrium in Infinite Games 165
10.10 Exercises 167

xxx vi Game Theory and Mechanism Design
11. Computation of Nash Equilibria 169
11.1 Supports and Nash Equilibria 169
11.2 A General Algorithm for Finding Nash Equilibria of Finite Strategic

Form Games 170
11.3 An Example for Computing Nash Equilibrium 173
11.5 Exercises 178
12. Complexity of Computing a Nash Equilibrium 181
12.1 Problems: NASH, BROUWER 181
12.2 The Class PPAB 182
12.3 NASH is PPAD-complete 185
12.4 Some Observations 185
13. Bayesian Games 189
13.1 Games with Incomplete Information 189
13.2 Examples of Bayesian Games 192
13.3 Type Agent Representation and the Selten Game 193
13.4 Bayesian Nash Equilibrium 196
13.5 Dominant Strategy Equilibria 198
13.7 Exercises 200
MECHANISM DESIGN 203
14. Introduction to Mechanism Design 205
14.1 Mechanism Design: Common Examples and History 205
14.2 Mechanism Design Environment 210
14.3 Direct and Indirect Mechanisms 212
14.4 Examples of Social Choice Functions 214
14.6 Exercises 221
15. Implementation of Social Choice Functions by Mechanisms 223
15.1 Implementation by Direct Mechanisms 223
15.2 Implementation by Indirect Mechanisms 227
15.3 Bayesian Game Induced by a Mechanism 230
15.4 Implementation of a Social Choice Function by a Mechanism . . .

231

Contents xxxvii
15.6 Exercises 235
16. Incentive Compatibility and Revelation Theorem 237
16.1 Incentive Compatibility 237

16.2 The Revelation Principle for Dominant Strategy Equilibrium . .
.
240
16.3 The Revelation Principle for Bayesian Nash Equilibrium 241
16.4 Properties of Social Choice Functions 242

16.6 Exercises 246
17. The Gibbard-Satterthwaite Impossibility Theorem 249
17.1 Preliminaries 249

17.2 The Gibbard-Satterthwaite Theorem 251
17.3 Proof of Gibbard Satterthwaite Theorem 255
17.4 Arrow's Impossibility Theorem 259
18. Vickrey-Clarke-Groves (VCG) Mechanisms 267
18.1 The Quasilinear Environment 267

18.2 Groves Mechanisms 273
18.3 Clarke (Pivotal) Mechanisms 277
18.4 Examples of VCG Mechanisms 278
18.6 Exercises 284
19. Mechanism Design Space in Quasilinear Environment 285
19.1 Groves Mechanisms and Strict Budget Balance 285

19.2 Clarke Mechanisms and Weak Budget Balance 286
19.3 Individual Rationality 288
19.4 VCG Mechanisms and Individual Rationality 289
19.5 The dAGVA Mechanism 292
19.6 A'lechanism Design Space in Quasilinear Environment 297
19.7 Linear Environment 297
19.9 Exercises 301
20. Auctions 303
20.1 Auction Types and Desirable Properties 303

20.2 Canonical Mechanisms for a Single Indivisible Item Auction .... 306
20.3 Revenue Equivalence of First Price and Second Price Auctions . .
308
20.4 Revenue Equivalence Theorem 310
xxxviii Game Theory and Mechanism, Design
20.5 Combinatorial Auctions 314

20.G Summary and References 317
20.7 Exercises 318
21. Optimal Mechanisms and Myerson Auction 321
21.1 Optimal Mechanisms 321

21.2 Myerson's Optimal Auction 323
21.3 Efficient Optimal Auctions 328
21.5 Exercises 330
22. Mechanism Design for Sponsored Search Auctions 331
22.1 Sponsored Search Auction 331

22.2 Sponsored Search Auction as a Mechanism Design Problem .... 333
22.3 Generalized First Price (GFP) Mechanism 335
22.4 Generalized Second Price (GSP) Mechanism 336
22.5 Vickrey-Clarke-Groves (VCG) Mechanism 337

22.6 Optimal (OPT) Mechanism 340
22.8 Exercises 348
23. Implementation in Ex-Post Nash Equilibrium 349
23.1 Implementation in Multiple Equilibria 349

23.2 Implementation in Nash Equilibrium 351
23.3 Implementability in Complete Information Setting 354
24. Further Topics in Mechanism Design 357
24.1 Characterization of DSIC Mechanisms 357

24.2 Dominant Strategy Implementation of BIC Rules 358
24.3 Interdependent Values 358
24.4 Other Forms of Implementability 359
24.5 Key Current Topics 360
24.6 Computational Issues in Mechanism Design 360
COOPERATIVE GAME THEORY 363
25. Correlated Strategies and Correlated Equilibrium 365
25.1 Games with Contracts 365
25.2 Correlated Strategies 367

Contents xxxix
25.3 Games with Communication 371

25.4 Correlated Equilibrium 374
25.6 Exercises 378
26. The Two Person Bargaining Problem 381
26.1 Nash Program 381

26.2 The Two Person Bargaining Problem 382
26.3 The Nash Axioms 385
26.4 The Nash Bargaining Solution 388
26.5 Proof of the Nash Bargaining Theorem 389
26.6 Egalitarian and Utilitarian Solutions 394
26.8 Exercises 397
27. Coalitional Games with Transferable Utility 399
27.1 Multi-Person Cooperative Games 399

27.2 Transferable Utility Games (TU Games) 403
27.3 TU Games with Special Structure 407
27.4 Cost Games 412
27.6 Exercises 413
28. The Core of Coalitional Games 415
28.1 The Core: Definition and Examples 415

28.2 Characterization of Games with Non-Empty Core 420
28.3 The Core of Convex Games 424
28.4 The Core of Cost Games 425
28.6 Exercises 427
29. The Shapley Value 429
29.1 The Shapley Axioms 430

29.2 Shaplcy's Theorem and Examples 432
29.3 Proof of the Shapley Theorem 435
29.4 Alternative Formulae for Shapley Value 439
29.5 Shapley Value of Convex Games 440
29.6 Shapley Shubik Power Index 441
-
29.7 Banzhaf Index 442
29.9 Exercises 444

xl Game Theory and Mechanism Design
30. Other Solution Concepts in Cooperative Game Theory 447
30.1 Stable Sets 447
30.2 Bargaining Set 449

30.3 Kernel 453
30.4 Nucleolus 454
30.5 The Gately Point 455
30.7 Exercises 458
31. Stable Matching 459
31.1 The Matching Problem 459
31.2 Matching Algorithms 460

31.3 Matching Markets 465
31.5 Exercises 467
32. Epilogue 469
32.1 Intent of the Book 469

32.2 To Probe Further 470
32.3 Conclusion 472
33. Mathematical Preliminaries 475
33.1 Probability Theory 475

33.2 Linear Algebra 477
33.3 Linear Programming and Duality 478
33.4 Mathematical Analysis 481
33.5 Computational Complexity Classes 484
Index 487

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MSc Lecture Notes Series

Opinions on the Book xi

About the Author xiii

Symbols and Notations xxix

1. Introduction and Overview 1

1.1 Game Theory: The Science of Strategic Interactions 1

NON-COOPERATIVE GAME THEORY 17

2. Key Notions in Game Theory 19

2.1 Strategic Form Games 19

2.7 Summary and References 27

3. Extensive Form Games 31

3.1 Illustrative Examples 31

3.2 Extensive Form Games: Definitions 34

3.3 Transforming Extensive Form to Strategic Form 37

3.4 Summary and References 40

4.2 Pennies with Simultaneous Moves 44

4.4 BOS (Bach or Stravinsky) Game 46

4.5 A Coordination Game 47

4.6 Prisoner's Dilemma Game 47

4.7 Company's Dilemma Game 48

4.8 A Non-Symmetric Company's Dilemma Game 49

4.9 A Duopoly Pricing Game 49

4.12 A Sealed Bid Auction 51

4.13 Pigou's Network Game 52

4.14 Braess Paradox Game 53

4.15 Summary and References 55

5. Dominant Strategy Equilibria 59

5.1 Strong Dominance 59

5.2 Weak Dominance 60

5.3 Very Weak Dominance 61

6. Pure Strategy Nash Equilibria 67

6.1 The Notion of Nash Equilibrium 67

6.2 Illustrative Examples of Pure Strategy Nash Equilibrium 70

6.3 Games without a Pure Strategy Nash Equilibrium 74

6.4 Interpretations of Nash Equilibrium 76

6.7 Equilibria in Extensive Form Games 82

6.8 Summary and References 85

7. Mixed Strategies and Mixed Strategy Nash Equilibrium 93

7.1 Mixed Strategies 93

7.2 Mixed Strategy Nash Equilibrium 95

7.3 Properties of Mixed Strategies 96

7.4 Necessary and Sufficient Conditions for a Profile to be a Mixed

Strategy Nash Equilibrium 98

7.5 Maxmin Values and Minmax Values in Mixed Strategies 104

7.6 Domination in Mixed Strategies 106

7.7 Summary and References 109

7.8 Exercises Ill

8. Utility Theory 115

8.1 Need for Utility Theory 115

8.2 Axioms of von Neumann -

Morgenstern Utility Theory 117

8.3 The von Neumann -

Morgenstern Theorem 121

8.4 Affine Transformations 123

8.5 Computing von Neumann -

Morgenstern Utilities 124

8.6 Risk Attitudes of Players 125

8.7 Summary and References 128

8.8 Exercises 129

9. Matrix Games 131

9.1 Examples of Matrix Games 132

9.2 Pure Strategies in Matrix Games 133

9.3 Saddle Points and Pure Strategy Nash Equilibria 135