Lecture #20

Recall the matching pennies game from last time

MATCHING PENNIES
Two friends take a penny in their hand and place it either heads up or tails up.
They have agreed to payoffs as follows:
If, when they open their hands, the pennies are the same side up then player 1 gets a
dollar from player 2.
If, when they open their hands, the pennies show opposite sides up then player 2 gets
a dollar from player 1.
Lets represent this game in both the extensive form and the normal form
Player 1
1
H T
H H T T
Player 2
1
(1)
(-1)
(-1)
(1)
(-1)
(1)
(1)
(-1)
1 2 H T
H (1, -1) (-1, 1)
T (-1, 1) (1, -1)
Remember that we said that this game has no pure strategy Nash equilibrium.
However, if these players mix strategies (and the game is finite) there will exist a mixed
strategy Nash equilibrium.
MIXED STRATEGY NASH EQUILIBRIA
If a player is going to mix on a set of pure strategies then all of the strategies in the
set must have the same payoff. Hence, the players probability distribution over these
strategies is arbitrary.
Of course, the other players payoffs do depend upon the probability distribution and
hence, a players mixed strategy is completely determined by the other players.
Lets clarify how this works by solving the mixed strategy Nash equilibrium for the
matching pennies game and then the (slightly) more complex Battle of the Sexes
game.
First, lets consider Player 1s payoffs if Player 2 plays H with a probability of and
plays T with a probability of (1 ).
1 2 H (prob. = ) T (prob. = (1 - ))
H (1, -1) (-1, 1)
T (-1, 1) (1, -1)
Denote Player 1s payoffs from playing H given that Player 2 mixes as
1
(H, ) and
also denote Player 1s payoffs from playing T given that Player 2 mixes as
1
(T, ).
Now, lets consider Player 1s payoff from playing H

1
(H, ) = (1) + (-1) (1 )

1
(H, ) = 1 +

1
(H, ) = 2 1
and what about Player 1s payoff from playing T

1
(T, ) = (-1) + (1) (1 )

1
(T, ) = - + 1

1
(T, ) = 1 2
Now, for Player 2 to make Player 1 indifferent between playing H or T they must
choose the that makes Player 1s payoffs the same for H and T (i.e.
1
(H, ) =
1
(T, )).
So

1
(H, ) =
1
(T, )
2 1 = 1 2
4 = 2
=
Now, lets consider Player 2s payoff from playing H if Player 1 mixes by playing H
with a probability of and plays T with a probability of (1 ).
Denote Player 2s payoffs from playing H given that Player 1 mixes as
2
(, H) and
also denote Player 2s payoffs from playing T given that Player 1 mixes as
2
(, T).
Now, lets consider Player 2s payoff from playing H
1 2 H T
H (prob. = ) (1, -1) (-1, 1)
T (prob. = (1 - )) (-1, 1) (1, -1)

2
(, H) = (-1) + (1) (1 )

2
(, H) = - + 1

2
(, H) = 1 - 2
and what about Player 2s payoff from playing T

2
(, T) = (1) + (- 1) (1 )

2
(, T) = 1 +

2
(, T) = 2 1
Now, for Player 1 to make Player 2 indifferent between playing H or T they must
choose the that makes Player 2s payoffs the same for H and T (i.e.
2
(, H) =
2
(, T)).
So

2
(, H) =
2
(, T)
1 2 = 2 1
4 = 2
=
Person 1s choice to play a mixed strategy depends on Person 2s choice of B. For
example, if Person 2 chooses to mix using = as above, then Player 1 will mix on
his pure strategies since he is indifferent between them (moreover, Person 1 will mix
such that Person 2 is indifferent between the pure strategies available to her). This
results in a Mixed Strategy Nash Equilibrium of the form:
[(, (1 )), (, (1 ))]
or in this case
(( , ), ( , ))
where the expected payoffs from these strategies are:

1
(H, ) = 2 1 2( ) 1 = 0

1
(T, ) = 1 2 1 2( ) = 0

2
(, H) = 1 - 2 1 2( ) = 0

2
(, T) = 2 1 2( ) 1= 0
Here, of course, the individual outcome of each individual play is still unknown but by
mixing strategies as above, each player is ensuring themselves the best payoff in a
large number of repeated trials.
BATTLE OF THE SEXES
Lets quickly refresh our memory with respect to Romeo and Juliets situation.
They are separated by many miles with no way of communicating. The last time that
they saw each other they agreed to go out on Saturday night but they could not agree
to which event they would attend before they were separated.
Juliet wants to go to the Manchester United game (soccer = sports, denoted as S) but
she knows that Romeo wants to go to see the Young Rolling Stones (music, denoted
as M).
Of course, Romeo and Juliet are quite taken with each other and would prefer to be
together than to be separate, however, each of them would derive more pleasure by
being together at the event that they prefer.
For example, Romeo wants to be with Juliet listening to music (his biggest payoff) and
Juliet wants to be with Romeo watching the soccer match (her biggest payoff).
Romeo and Juliet must simultaneously choose (without having agreed upon where to
meet) which venue to arrive at.
We represented this game in both the extensive form and the normal form as follows:
Romeo
1
M S
M M S S
Juliet
1
(50)
(20)
(0)
(0)
(5)
(5)
(20)
(50)
Romeo Juliet M S
M (50, 20) (5, 5)
S (0, 0) (20, 50)
If Romeo chooses M then Juliets best response is
M. Since M is also Romeos best response when
Juliet chooses M we have a mutual best response.
Thus, (M, M) is a pure strategy Nash Equilibrium.
If Romeo chooses S then Juliets best response is
S and by inspection we can see this is also
Romeos best response to Juliet picking S. Thus,
(S, S) is also a pure strategy Nash Equilibrium.
Great! Now they have no problem, right?
WRONG! The Nash equilibria only happen if one of the two players decides to go to
the event that they dont want to go to.
So weve still got a problem! Now, lets suppose that they are both unable to learn
from their past experiences (a realistic problem in some couples) and this same
situation presents itself every single time that they agree to meet.
We can investigate this game using mixed strategy Nash analysis and find out how
each of them can mix between their pure strategies to ensure themselves at least a
minimum guaranteed payoff (in repeated trials).
For illustration purposes lets change the payoff matrix a bit so that Juliet gets
proportionally more pleasure from sports than Romeo gets from music. For example,
Romeo Juliet M S
M (60, 20) (5, 5)
S (0, 0) (40, 80)
MIXED STRATEGY NASH EQUILIBRIA
Remember, our pure strategy Nash Equilibria for this game were (M, M) and (S, S).
First, lets consider Romeos payoffs if Juliet mixes (i.e. plays M with a probability of
and plays S with a probability of (1 )).
Romeo Juliet M (prob. = ) S (prob. = (1 ))
M (60, 20) (5, 5)
S (0, 0) (40, 80)
Denote Romeos payoffs from playing M given that Juliet mixes as
R
(M, ) and
also denote Romeos payoffs from playing S given that Juliet mixes as
R
(S, ).
Now, lets consider Romeos payoff from playing M

R
(M, ) = (60) + (5) (1 )

R
(M, ) = 60 + 5 5

R
(M, ) = 55 + 5
and what about Romeos payoff from playing S

R
(S, ) = (0) + (40) (1 )

R
(S, ) = 40 40
Now, for Juliet to make Romeo indifferent between playing M or S she must
choose the that makes Romeos payoffs the same for M and S (i.e.
R
(M, )
=
R
(S, )).
So

R
(M, ) =
R
(S, )
55 + 5 = 40 40
95 = 35
= 7 / 19
(1 ) = 12 / 19
Now, lets consider Juliets payoffs if Romeo mixes (i.e. by playing M with a
probability of and playing S with a probability of (1 )).
Romeo Juliet M S
M (prob. = ) (60, 20) (5, 5)
S (prob. = (1 - )) (0, 0) (40, 80)
Denote Juliets payoffs from playing M given that Romeo mixes as
J
(, M)
and also denote Juliets payoffs from playing S given that Romeo mixes as
J
(, S).
Now, lets consider Juliets payoff from playing M

J
(, M) = (20) + (0) (1 )

J
(, M) = 20
and what about Juliets payoff from playing S

J
(, S) = (5) + (80) (1 )

J
(, S) = 5 + 80 - 80

J
(, S) = 80 - 75
Now, for Romeo to make Juliet indifferent between playing M or S he must
choose the that makes Juliets payoffs the same for M and S (i.e.
J
(, M) =

J
(, S)).
So

J
(, M) =
J
(, S)
20 = 80 - 75
95 = 80
= 16 / 19
(1 ) = 3 / 19
This results in a Mixed Strategy Nash Equilibrium of the form:
[(, (1 )), (, (1 ))]
or in this case
((16/19 , 3/19), (7/19 , 12/19))
where the expected payoffs from these strategies are:

R
(M, ) = 55 + 5 55(7/19) + 5 = 480/19 (or 25.263)

R
(S, ) = 40 40 40 40(7/19) = 480/19 (or 25.263)

J
(, M) = 20 20(16/19) = 320/19 (or 16.842)

J
(, S) = 80 75 80 75(16/19) = 320/19 (or 16.842)
Why does Romeo get a higher expected payoff than Juliet?
Why can Romeo mix with = 16 / 19 on music and only 3 / 19 on sports?
Does Romeo have some advantage or power in this game?
If Romeo and Juliet mix strategies then their payoffs will be in the interior of their utility
possibility frontier.
Consider the situation where they always both go to the orchestra (M, M). Well call this
point A and the payoffs are (60, 20).
Also, consider the situation where they always go to the soccer match (S, S). Well call
this point B and the payoffs are (40, 80).
Further, consider the mixed strategy Nash Equilibrium that we just figured out ((16/19 ,
3/19), (7/19 , 12/19)). Well call this point C and the payoffs are (25.263, 16.842).
We should be able to see (even without the diagram that follows) that point C is interior to
the utility possibilities created by connecting point A and point B with a line segment.
If Romeo and Juliet could coordinate
their actions, would they be able to
reach this utility possibility frontier?
Of course!
Juliet
Romeo
A
C
B
60 20 40 80
80
60
40
20
Suppose that they agree that if they went to sports last time then the next time they
would go to the music concert. Then over repeated trials they would go to each
venue half of the time and be guaranteed to meet. Their expected utility would then
become:
E (U
ROMEO
) = (60) + (40) = 50
E (U
JULIET
) = (20) + (80) = 50
Lets call this point D where the payoffs are (50, 50).
Now, just to be clear, it doesnt need to be a fair split to be efficient (i.e. on the UPF).
Suppose that they agree that they would go to sports twice in a row and then to music
once (in an exactly repeated pattern). Then, over time, they would go to sports 2/3 of
the time and music concerts 1/3 of the time. Their expected utility would then become:
E (U
ROMEO
) = 1/3 (60) + 2/3 (40) = 46.66666
E (U
JULIET
) = 1/3 (20) + 2/3 (80) = 66.66666
Lets call this point E where the payoffs are (46.66666, 66.66666).
The key thing to recognize is that points A, B, D, E constitute situations where Romeo
and Juliet communicate and agree on a pattern of meeting behaviours whereas point C
is the mixed strategy Nash outcome in a situation of uncertainty about their meeting
behaviours.
The following diagram suggests that when they can communicate and agree, they can
reach the boundary of their utility possibility setwhen theres uncertainty they cant.
This battle of the sexes is a problem of
coordination. If the individuals can coordinate
(communicate and agree on) their actions, then
the inefficiencies due to uncertainty disappear.
Juliet
Romeo
A
C
B
60 20 40 80
80
60
40
20
D
E
HOMEWORK:
1. Describe, in your own words, how a market can fail due to hidden information.
2. Find the mixed strategy Nash Equilibrium for the following game. What are the
expected payoffs for the players?
Dave Sally A B
A (78, 31) (8, 8)
B (2, 2) (19, 81)