1. UNIT II: The Basic Theory Zero-sum Games Nonzero-sum Games Nash Equilibrium: Properties and Problems Bargaining Games Review Midterm3/23 3/9

2. Review Terms Counting Strategies Prudent v. Best-Response Strategies Graduate Assignment Review

3. Dominant Strategy: A strategy that is best no matter what the opponent(s) choose(s). Prudent Strategy: A prudent strategy maximizes the minimum payoff a player can get from playing different strategies. Such a strategy is simply max s min t P(s,t) for player i. Mixed Strategy: A mixed strategy for player i is a probability distribution over all strategies available to player i. Best Response Str’gy: A strategy, s’, is a best response strategy iff P i (s’,t) > P i (s,t) for all s. Dominated Strategy:A strategy is dominated if it is never a best response strategy.

4. Review Saddlepoint: A set of prudent strategies (one for each player), s. t. (s*, t*) is a saddlepoint, iff maxmin = minmax. Nash Equilibrium: a set of best response strategies (one for each player), (s’,t’) such that s’ is a best response to t’ and t’ is a b.r. to s’. Subgame: a part (or subset) of an extensive game, starting at a singleton node (not the initial node) and continuing to payoffs. Subgame Perfect Nash Equilibrium (SPNE): a NE achieved by strategies that also constitute NE in each subgame. eliminates NE in which the players threats are not credible.

5. Counting Strategies Left Right L R L R -2 4 2 -1 Player 1 Player 2 GAME 2: Button-Button Player 2 has 4 strategies: -2 4 -2 4 2 -1 -1 2 LRLR LL RR LR RL

6. Counting Strategies Left Right L R L R -2 4 2 -1 Player 1 Player 2 GAME 2: Button-Button Player 2 has 4 strategies: -2 4 -2 4 2 -1 -1 2 LRLR LL RR LR RL

7. Counting Strategies Left Right L R L R -2 4 2 -1 Player 1 Player 2 GAME 2: Button-Button Player 2 has 4 strategies: -2 4 -2 4 2 -1 -1 2 LRLR LL RR LR RL

8. Counting Strategies Left Right L R L R -2 4 2 -1 Player 1 Player 2 GAME 2: Button-Button Player 2 has 4 strategies: -2 4 -2 4 2 -1 -1 2 LRLR LL RR LR RL

9. Counting Strategies Left Right L R L R -2 4 2 -1 Player 1 Player 2 If Player 2 cannot observe Player 1’s choice … Player 2 will have fewer strategies. GAME 2: Button-Button

10. Counting Strategies Left Right L R L R -2 4 2 -1 Player 1 Player 2 -2 4 2 -1 L R L R GAME 2: Button-Button

11. Opera Fight O F O F (2,1) (0,0) (0,0) (1,2) Player 1 Player 2 2, 1 0, 0 0, 0 1, 2 O F O F Battle of the Sexes Find all the NE of the game. Prudence v. Best Response

12. Opera Fight O F O F (2,1) (0,0) (0,0) (1,2) Player 1 Player 2 2, 1 0, 0 0, 0 1, 2 O F O F Battle of the Sexes NE = {(1, 1); (0, 0); } Prudence v. Best Response

13. Opera Fight O F O F (2,1) (0,0) (0,0) (1,2) Player 1 Player 2 2, 1 0, 0 0, 0 1, 2 O F O F Battle of the Sexes Prudence v. Best Response NE = {(O,O); (F,F); }

14. O F P1P1 P221P221 Battle of the Sexes Mixed Nash Equilibrium Prudence v. Best Response O F 2, 1 0, 0 0, 0 1, 2 NE (1,1) NE (0,0) 1 2 NE = {(1, 1); (0, 0); (MNE)}

15. O F 2, 1 0, 0 0, 0 1, 2 O F NE = {(1, 1); (0, 0); (MNE)} Battle of the Sexes Prudence v. Best Response Let (p,1-p) = prob 1 (O, F ) (q,1-q) = prob 2 (O, F )

16. O F 2, 1 0, 0 0, 0 1, 2 O F NE = {(1, 1); (0, 0); (MNE)} Battle of the Sexes Prudence v. Best Response Let (p,1-p) = prob 1 (O, F ) (q,1-q) = prob 2 (O, F ) Then EP 1 (Olq) = 2q EP 1 (Flq) = 1-1q EP 2 (Olp) = 1p EP 2 (Flp) = 2-2p

17. O F 2, 1 0, 0 0, 0 1, 2 O F NE = {(1, 1); (0, 0); ( 2/3,1/3 )} } Battle of the Sexes Prudence v. Best Response Let (p,1-p) = prob 1 (O, F ) (q,1-q) = prob 2 (O, F ) Then EP 1 (Olq) = 2q EP 1 (Flq) = 1-1q q* = 1/3 EP 2 (Olp) = 1p EP 2 (Flp) = 2-2p p* = 2/3

18. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes EP 1 2/3 0 2 p=1 p=0 Prudence v. Best Response p=1 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Player 1’s Expected Payoff

19. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes EP 1 2/3 0 2 p=1 p=0 Prudence v. Best Response NE = {(1, 1); (0, 0); ( 2/3,1/3 )} EP 1 = 2q +0(1-q) Player 1’s Expected Payoff

20. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes EP 1 1 2/3 0 2020 p=1 p=0 Prudence v. Best Response p=1 p=0 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Player 1’s Expected Payoff

21. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes EP 1 1 2/3 0 2020 p=1 p=0 Prudence v. Best Response p=1 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} EP 1 = 0q+1 (1-q) Player 1’s Expected Payoff

22. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes EP 1 1 2/3 0 2020 p=1 p=0 Prudence v. Best Response Opera Fight NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Player 1’s Expected Payoff

23. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes EP 1 1 2/3 0 2020 p=1 p=0 Prudence v. Best Response p=1 p=0 0<p<1 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Player 1’s Expected Payoff q = 1/3

24. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes 2020 p=1 p=0 Prudence v. Best Response p=1 p=0 p = 2/3 4/3 EP 1 2/3 1/3 If Player 1 uses her (mixed) b-r strategy (p=2/3), her expected payoff varies from 1/3 to 4/3. NE = {(1, 1); (0, 0); ( 2/3,1/3 )} q = 1/3

25. q=1 q=0 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes 2020 p=1 p=0 Prudence v. Best Response p=1 p=0 EP 1 2/3 1/3 2/3 If Player 2 uses his (mixed) b-r strategy (q=1/3), the expected payoff to Player 1 is 2/3, for all p. q = 1/3 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} 4/3

26. O F 2, 1 0, 0 0, 0 1, 2 O F Battle of the Sexes Prudence v. Best Response Find the prudent strategy for each player.

27. O F 2, 1 0, 0 0, 0 1, 2 O F Battle of the Sexes Prudence v. Best Response Let (p,1-p) = prob 1 (O, F ) (q,1-q) = prob 2 (O, F ) Then EP 1 (Olp) = 2p EP 1 (Flp) = 1-1p p* = 1/3 EP 2 (Oiq) = 1q EP 2 (Flq) = 2-2q q* = 2/3 Prudent strategies: 1/3; 2/3

28. O F 2, 1 0, 0 0, 0 1, 2 O F NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Battle of the Sexes Prudence v. Best Response Let (p,1-p) = prob 1 (O, F ) (q,1-q) = prob 2 (O, F ) Then EP 1 (Olq) = 2q EP 1 (Flq) = 1-1q q* = 1/3 EP 2 (Olp) = 1p EP 2 (Flp) = 2-2p p* = 2/3

29. O F 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes 2020 O F Prudence v. Best Response p=1 p=0 p = 2/3 4/3 If Player 1 uses her prudent strategy (p=1/3), expected payoff is 2/3 no matter what player 2 does NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Prudent: {( 1/3, 2/3 )} EP 1 2/3 1/3 p = 1/3

30. O F 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes 2020 O F Prudence v. Best Response p=1 p=0 p = 2/3 4/3 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Prudent: {( 1/3, 2/3 )} EP 1 2/3 1/3 q = 1/3 If both players use (mixed) b-r strategies, expected payoff is 2/3 for each. p = 1/3

31. O F P1P1 P 2 2 1 2/3 Battle of the Sexes Prudence v. Best Response O F 2, 1 0, 0 0, 0 1, 2 NE (1,1) NE (0,0) 2/3 1 2 If both players use (mixed) b-r strategies, expected payoff is 2/3 for each. NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Prudent: {( 1/3, 2/3 )}

32. O F P1P1 P 2 2 1 2/3 Battle of the Sexes Prudence v. Best Response O F 2, 1 0, 0 0, 0 1, 2 NE (1,1) NE (0,0) 2/3 1 2 If both players use prudent strategies, expected payoff is 2/3 for each. NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Prudent: {( 1/3, 2/3 )}

33. O F P1P1 P 2 2 1 2/3 Battle of the Sexes Prudence v. Best Response O F 2, 1 0, 0 0, 0 1, 2 NE (1,1) NE (0,0) 2/3 1 2 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Prudent: {( 1/3, 2/3 )} BATNA: Best Alternative to a Negotiated Agreement BATNA

34. O F P1P1 P 2 2 1 2/3 Battle of the Sexes Prudence v. Best Response O F 2, 1 0, 0 0, 0 1, 2 NE (1,1) NE (0,0) 2/3 1 2 NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Prudent: {( 1/3, 2/3 )} Is the pair of prudent strategies an equilibrium?

35. O F 2, 1 0, 0 0, 0 1, 2 q Battle of the Sexes 2020 O F Prudence v. Best Response p=1 p=0 p = 2/3 4/3 NO: Player 1’s best response to Player 2’s prudent strategy (q=2/3) is Opera (p=1). NE = {(1, 1); (0, 0); ( 2/3,1/3 )} Prudent: {( 1/3, 2/3 )} EP 1 2/3 1/3 2/3 q = 1/3 2/3 Opera p = 1/3

36. Review [I]f game theory is to provide a […] solution to a game- theoretic problem then the solution must be a Nash equilibrium in the following sense. Suppose that game theory makes a unique prediction about the strategy each player will choose. In order for this prediction to be correct, it is necessary that each player be willing to choose the strategy predicted by the theory. Thus each player’s predicted strategy must be that player’s best response to the predicted strategies of the other players. Such a prediction could be called strategically stable or self- enforcing, because no single player wants to deviate from his or her predicted strategy (Gibbons: 8).

37. Review SADDLEPOINT v. NASH EQUILIBRIUM STABILITY:Is it self-enforcing?YES UNIQUENESS: Does it identify an unambiguous course of action? YES NO EFFICIENCY: Is it at least as good as any other outcome for all players? --- (YES) NOT ALWAYS SECURITY: Does it ensure a minimum payoff? YES NO EXISTENCE: Does a solution always exist for the class of games? YESYES

38. Review 1.Indeterminacy: Nash equilibria are not usually unique. 2. Inefficiency: Even when they are unique, NE are not always efficient. Problems of Nash Equilibrium

39. Review T 1 T 2 S 1 S 2 5,5 0,1 1,0 3,3 Multiple and Inefficient Nash Equilibria When is it advisable to play a prudent strategy in a nonzero-sum game? Problems of Nash Equilibrium

40. Review T 1 T 2 S 1 S 2 5,5 -99,1 1,-99 3,3 Multiple and Inefficient Nash Equilibria When is it advisable to play a prudent strategy in a nonzero-sum game? What do we need to know/believe about the other player? Problems of Nash Equilibrium

41. Bargaining Games Bargaining games are fundamental to understanding the price determination mechanism in “small” markets. The central issue in all bargaining games is credibility: the strategic use of threats, bluffs, and promises. When information is asymmetric, profitable exchanges may be “left on the table.” In such cases, there is an incentive to make oneself credible (e.g., appraisals; audits; “reputable” agents; brand names; lemons laws; “corporate governance”).