## Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

)

1

EEG-UM Microeconomia III 1

Dynamic Games of Complete

Information

Dynamic Games of Complete and Perfect

Information

EEG-UM Microeconomia III 2

Outline of dynamic games of

complete information

Dynamic games of complete information

Extensive-form representation

Dynamic games of complete and perfect information

Game tree

Subgame-perfect Nash equilibrium

Backward induction

Applications

Dynamic games of complete and imperfect information

More applications

Repeated games

JDIC (Mod1)

2

EEG-UM Microeconomia III 3

Agenda

Examples

Entry game

Sequential-move matching pennies

Extensive-form representation

Dynamic games of complete and perfect

information

Game tree

EEG-UM Microeconomia III 4

Entry game

An incumbent monopolist faces the possibility of entry by a

challenger.

The challenger may choose to enter or stay out.

If the challenger enters, the incumbent can choose either to

accommodate or to fight.

The payoffs are common knowledge.

Challenger

In Out

Incumbent

A F

1, 2

2, 1 0, 0

The first number is the

payoff of the challenger.

The second number is the

payoff of the incumbent.

JDIC (Mod1)

3

EEG-UM Microeconomia III 5

Sequential-move matching pennies

Each of the two players has

a penny.

Player 1 first chooses

whether to show the Head

or the Tail.

After observing player 1´s

choice, player 2 chooses to

show Head or Tail

Both players know the

following rules:

If two pennies match (both

heads or both tails) then

player 2 wins player 1´s

penny.

Otherwise, player 1 wins

player 2´s penny.

Player 1

Player 2

H T

-1, 1 1, -1

H T

Player 2

H T

1, -1 -1, 1

EEG-UM Microeconomia III 6

Dynamic (or sequential-move) games

of complete information

A set of players

Who moves when and what action choices

are available?

What do players know when they move?

Players´ payoffs are determined by their

choices.

All these are common knowledge among

the players.

JDIC (Mod1)

4

EEG-UM Microeconomia III 7

Definition: extensive-form representation

The extensive-form representation of a

game specifies:

the players in the game

when each player has the move

what each player can do at each of his or her

opportunities to move

what each player knows at each of his or her

opportunities to move

the payoff received by each player for each

combination of moves that could be chosen by

the players

EEG-UM Microeconomia III 8

Dynamic games of complete and

perfect information

Perfect information

All previous moves are observed before the next

move is chosen.

A player knows Who has moved What before

she makes a decision

JDIC (Mod1)

5

EEG-UM Microeconomia III 9

Game tree

A game tree has a set of

nodes and a set of

edges such that

each edge connects

two nodes (these two

nodes are said to be

adjacent)

for any pair of nodes,

there is a unique path

that connects these

two nodes

x

0

x

1

x

2

x

3

x

4

x

5

x

6

x

7 x

8

a node

an edge connecting

nodes x

1

and x

5

a path from

x

0

to x

4

EEG-UM Microeconomia III 10

Game tree

A path is a sequence of distinct

nodes y

1

, y

2

, y

3

, ..., y

n-1

, y

n

such that y

i

and y

i+1

are

adjacent, for i=1, 2, ..., n-1.

We say that this path is from y

1

to y

n

.

We can also use the sequence

of edges induced by these

nodes to denote the path.

The length of a path is the

number of edges contained in

the path.

Example 1: x

0

, x

2

, x

3

, x

7

is a

path of length 3.

Example 2: x

4

, x

1

, x

0

, x

2

, x

6

is a

path of length 4

x

0

x

1

x

2

x

3

x

4

x

5

x

6

x

7 x

8

a path from

x

0

to x

4

JDIC (Mod1)

6

EEG-UM Microeconomia III 11

Game tree

There is a special node x

0

called the root of the tree

which is the beginning of the

game

The nodes adjacent to x

0

are

successors of x

0

. The

successors of x

0

are x

1

, x

2

For any two adjacent nodes,

the node that is connected to

the root by a longer path is a

successor of the other node.

Example 3: x

7

is a successor

of x

3

because they are

adjacent and the path from

x

7

to x

0

is longer than the

path from x

3

to x

0

x

0

x

1

x

2

x

3

x

4

x

5

x

6

x

7 x

8

EEG-UM Microeconomia III 12

Game tree

If a node x is a successor

of another node y then y

is called a predecessor of

x.

In a game tree, any node

other than the root has a

unique predecessor.

Any node that has no

successor is called a

terminal node which is a

possible end of the game

Example 4: x

4

, x

5

, x

6

, x

7

,

x

8

are terminal nodes

x

0

x

1

x

2

x

3

x

4

x

5

x

6

x

7 x

8

JDIC (Mod1)

7

EEG-UM Microeconomia III 13

Game tree

Any node other than a

terminal node represents

some player.

For a node other than a

terminal node, the edges

that connect it with its

successors represent the

actions available to the

player represented by

the node

Player 1

Player 2

H T

-1, 1 1, -1

H T

Player 2

H T

1, -1 -1, 1

EEG-UM Microeconomia III 14

Game tree

A path from the root to a

terminal node represents

a complete sequence of

moves which determines

the payoff at the

terminal node

Player 1

Player 2

H T

-1, 1 1, -1

H T

Player 2

H T

1, -1 -1, 1

JDIC (Mod1)

8

EEG-UM Microeconomia III 15

Strategy

A strategy for a player is a complete plan of

actions.

It specifies a feasible action for the player in

every contingency in which the player might be

called on to act.

EEG-UM Microeconomia III 16

Entry game

Challenger´s strategies

In

Out

Incumbent´s strategies

Accommodate (if challenger plays In)

Fight (if challenger plays In)

Payoffs

Normal-form representation

Incumbent

Fight

1 , 2 1 , 2

Out

Challenger

0 , 0 2 , 1 In

Accommodate

JDIC (Mod1)

9

EEG-UM Microeconomia III 17

Strategy and payoff

In a game tree, a strategy for a player is

represented by a set of edges.

A combination of strategies (sets of edges),

one for each player, induce one path from the

root to a terminal node, which determines the

payoffs of all players

EEG-UM Microeconomia III 18

Strategy and payoff

A strategy for a player

is a complete plan of

actions.

It specifies a feasible

action for the player in

every contingency in

which the player might

be called on to act.

It specifies what the

player does at each of

her nodes

Player 1

Player 2

H T

-1, 1 1, -1

H T

Player 2

H T

1, -1 -1, 1

a strategy for

player 1: H

a strategy for player 2: H if player 1 plays

H, T if player 1 plays T (written as HT)

Player 1’s payoff is -1 and player 2’s payoff is

1 if player 1 plays H and player 2 plays HT

JDIC (Mod1)

10

EEG-UM Microeconomia III 19

Sequential-move matching pennies

Player 1´s strategies

Head

Tail

Player 2´s strategies

H if player 1 plays H, H if player 1 plays T

H if player 1 plays H, T if player 1 plays T

T if player 1 plays H, H if player 1 plays T

T if player 1 plays H, T if player 1 plays T

Player 2´s strategies are denoted by HH, HT, TH and TT,

respectively.

EEG-UM Microeconomia III 20

Sequential-move matching pennies

Their payoffs

Normal-form representation

1 , -1

1 , -1

TH

Player 2

-1 , 1

1 , -1

TT HT

-1 , 1 1 , -1

T

Player

1

-1 , 1 -1 , 1

H

HH

JDIC (Mod1)

11

EEG-UM Microeconomia III 21

Nash equilibrium

The set of Nash equilibria in a dynamic game

of complete information is the set of Nash

equilibria of its normal-form.

EEG-UM Microeconomia III 22

Find Nash equilibrium

How to find the Nash equilibria in a dynamic

game of complete information

Construct the normal-form of the dynamic game of

complete information

Find the Nash equilibria in the normal-form

JDIC (Mod1)

12

EEG-UM Microeconomia III 23

Nash equilibria in entry game

Two Nash equilibria

( In, Accommodate )

( Out, Fight )

Does the second Nash

equilibrium make sense?

Non-creditable threats

Incumbent

Fight

1 , 2 1 , 2

Out

Challenger

0 , 0 2 , 1 In

Accommodate

Challenger

In Out

Incumbent

A F

1, 2

2, 1 0, 0

EEG-UM Microeconomia III 24

Remove nonreasonable Nash equilibrium

Subgame perfect Nash equilibrium is a

refinement of Nash equilibrium

It can rule out nonreasonable Nash equilibria

or non-creditable threats

We first need to define subgame

JDIC (Mod1)

13

EEG-UM Microeconomia III 25

Subgame

A subgame of a game tree

begins at a nonterminal node

and includes all the nodes

and edges following the

nonterminal node

A subgame beginning at a

nonterminal node x can be

obtained as follows:

remove the edge connecting

x and its predecessor

the connected part

containing x is the subgame

-1, 1

Player 1

Player 2

H T

1, -1

H T

Player 2

H T

1, -1 -1, 1

a subgame

EEG-UM Microeconomia III 26

Subgame: example

Player 2

E F

Player 1

G H

3, 1

1, 2 0, 0

Player 1

C D

2, 0

Player 2

E F

Player 1

G H

3, 1

1, 2 0, 0

Player 1

G H

1, 2 0, 0

JDIC (Mod1)

14

EEG-UM Microeconomia III 27

Subgame-perfect Nash equilibrium

A Nash equilibrium of a dynamic game is

subgame-perfect if the strategies of the Nash

equilibrium constitute a Nash equilibrium in

every subgame of the game.

Subgame-perfect Nash equilibrium is a Nash

equilibrium.

EEG-UM Microeconomia III 28

Entry game

Two Nash equilibria

( In, Accommodate ) is subgame-perfect.

( Out, Fight ) is not subgame-perfect because it does not

induce a Nash equilibrium in the subgame beginning at

Incumbent.

Challenger

In Out

Incumbent

A F

1, 2

2, 1 0, 0

Incumbent

A F

2, 1 0, 0

Accommodate is the Nash

equilibrium in this subgame.

JDIC (Mod1)

15

EEG-UM Microeconomia III 29

Find subgame perfect Nash equilibria:

backward induction

Starting with those smallest subgames

Then move backward until the root is reached

Challenger

In Out

Incumbent

A F

1, 2

2, 1 0, 0

The first number is the

payoff of the challenger.

The second number is the

payoff of the incumbent.

EEG-UM Microeconomia III 30

Find subgame perfect Nash equilibria:

backward induction

Subgame perfect Nash equilibrium (DG, E)

Player 1 plays D, and plays G if player 2 plays E

Player 2 plays E if player 1 plays C

Player 2

E F

Player 1

G H

3, 1

1, 2 0, 0

Player 1

C D

2, 0

JDIC (Mod1)

16

EEG-UM Microeconomia III 31

Existence of subgame-perfect Nash

equilibrium

Every finite dynamic game of complete and

perfect information has a subgame-perfect

Nash equilibrium that can be found by

backward induction.

EEG-UM Microeconomia III 32

Backward induction: illustration

Subgame-perfect Nash equilibrium (C, EH).

player 1 plays C;

player 2 plays E if player 1 plays C, plays H if player 1

plays D.

Player 1

C D

Player 2

E F

3, 0 2, 1

Player 2

G H

1, 3 0, 2

JDIC (Mod1)

17

EEG-UM Microeconomia III 33

Multiple subgame-perfect Nash equilibria:

illustration

Subgame-perfect Nash equilibrium (D, FHK).

player 1 plays D

player 2 plays F if player 1 plays C, plays H if player 1

plays D, plays K if player 1 plays E.

Player 1

C

D

Player 2

F G

1, 0 0, 1

Player 2

J K

1, 3 2, 2

Player 2

H I

2, 1 1, 1

E

EEG-UM Microeconomia III 34

Multiple subgame-perfect Nash equilibria

Subgame-perfect Nash equilibrium (E, FHK).

player 1 plays E;

player 2 plays F if player 1 plays C, plays H if player 1

plays D, plays K if player 1 plays E.

Player 1

C

D

Player 2

F G

1, 0 0, 1

Player 2

J K

1, 3 2, 2

Player 2

H I

2, 1 1, 1

E

JDIC (Mod1)

18

EEG-UM Microeconomia III 35

Multiple subgame-perfect Nash equilibria

Subgame-perfect Nash equilibrium (D, FIK).

player 1 plays D;

player 2 plays F if player 1 plays C, plays I if player 1

plays D, plays K if player 1 plays E.

Player 1

C

D

Player 2

F G

1, 0 0, 1

Player 2

J K

1, 3 2, 2

Player 2

H I

2, 1 1, 1

E

EEG-UM Microeconomia III 36

Stackelberg model of duopoly

A homogeneous product is produced by only two firms:

firm 1 and firm 2. The quantities are denoted by q

1

and

q

2

, respectively.

The timing of this game is as follows:

Firm 1 chooses a quantity q

1

≥0.

Firm 2 observes q

1

and then chooses a quantity q

2

≥0.

The market priced is P(Q)=a –Q, where a is a constant

number and Q=q

1

+q

2

.

The cost to firm i of producing quantity q

i

is C

i

(q

i

)=cq

i

.

Payoff functions:

u

1

(q

1

, q

2

)=q

1

(a–(q

1

+q

2

)–c)

u

2

(q

1

, q

2

)=q

2

(a–(q

1

+q

2

)–c)

JDIC (Mod1)

19

EEG-UM Microeconomia III 37

Stackelberg model of duopoly

Find the subgame-perfect Nash equilibrium

by backward induction

We first solve firm 2’s problem for any q

1

≥0 to get

firm 2’s best response to q

1

. That is, we first solve

all the subgames beginning at firm 2.

Then we solve firm 1’s problem. That is, solve the

subgame beginning at firm 1

EEG-UM Microeconomia III 38

Stackelberg model of duopoly

Solve firm 2’s problem for any q

1

≥0 to get firm 2’s best

response to q

1

.

Max u

2

(q

1

, q

2

)=q

2

(a–(q

1

+q

2

)–c)

subject to 0 ≤ q

2

≤ +

FOC: a – 2q

2

– q

1

– c = 0

Firm 2’s best response,

R

2

(q

1

) = (a – q

1

– c)/2 if q

1

≤ ≤≤ ≤ a– c

= 0 if q

1

> a– c

Note: Osborne used b

2

(q

1

) instead of R

2

(q

1

)

JDIC (Mod1)

20

EEG-UM Microeconomia III 39

Stackelberg model of duopoly

Solve firm 1’s problem. Note firm 1 can also solve firm

2’s problem. That is, firm 1 knows firm 2’s best

response to any q

1

. Hence, firm 1’s problem is

Max u

1

(q

1

, R

2

(q

1

))=q

1

(a–(q

1

+R

2

(q

1

))–c)

subject to 0 ≤ q

1

≤ +

That is,

Max u

1

(q

1

, R

2

(q

1

))=q

1

(a–q

1

–c)/2

subject to 0 ≤ q

1

≤ +

FOC: (a – 2q

1

– c)/2 = 0

q

1

= (a – c)/2

EEG-UM Microeconomia III 40

Stackelberg model of duopoly

Subgame-perfect Nash equilibrium

( (a – c)/2, R

2

(q

1

) ), where

R

2

(q

1

) = (a – q

1

– c)/2 if q

1

≤ ≤≤ ≤ a– c

= 0 if q

1

> a– c

That is, firm 1 chooses a quantity (a – c)/2, firm 2

chooses a quantity R

2

(q

1

) if firm 1 chooses a

quantity q

1

.

The backward induction outcome is ( (a – c)/2, (a – c)/4

).

Firm 1 chooses a quantity (a – c)/2, firm 2 chooses a

quantity (a – c)/4.

JDIC (Mod1)

21

EEG-UM Microeconomia III 41

Stackelberg model of duopoly

Firm 1 produces

q

1

=(a – c)/2 and its profit

q

1

(a–(q

1

+ q

2

)–c)=(a–c)

2

/8

Firm 2 produces

q

2

=(a – c)/4 and its profit

q

2

(a–(q

1

+ q

2

)–c)=(a–c)

2

/16

The aggregate quantity is 3(a – c)/4.

EEG-UM Microeconomia III 42

Cournot model of duopoly

Firm 1 produces

q

1

=(a – c)/3 and its profit

q

1

(a–(q

1

+ q

2

)–c)=(a–c)

2

/9

Firm 2 produces

q

2

=(a – c)/3 and its profit

q

2

(a–(q

1

+ q

2

)–c)=(a–c)

2

/9

The aggregate quantity is 2(a – c)/3.

JDIC (Mod1)

22

EEG-UM Microeconomia III 43

Monopoly

Suppose that only one firm, a monopoly, produces the

product. The monopoly solves the following problem to

determine the quantity q

m

.

Max q

m

(a–q

m

–c)

subject to 0 ≤ q

m

≤ +

FOC: a – 2q

m

– c = 0

q

m

= (a – c)/2

Monopoly produces

q

m

=(a – c)/2 and its profit

q

m

(a–q

m

–c)=(a–c)

2

/4

EEG-UM Microeconomia III 44

Sequential-move Bertrand model of

duopoly (differentiated products)

Two firms: firm 1 and firm 2.

Each firm chooses the price for its product. The prices

are denoted by p

1

and p

2

, respectively.

The timing of this game as follows.

Firm 1 chooses a price p

1

≥0.

Firm 2 observes p

1

and then chooses a price p

2

≥0.

The quantity that consumers demand from firm 1: q

1

(p

1

,

p

2

) = a – p

1

+ bp

2

.

The quantity that consumers demand from firm 2: q

2

(p

1

,

p

2

) = a – p

2

+ bp

1

.

The cost to firm i of producing quantity q

i

is C

i

(q

i

)=cq

i

.

JDIC (Mod1)

23

EEG-UM Microeconomia III 45

Sequential-move Bertrand model of

duopoly (differentiated products)

Solve firm 2’s problem for any p

1

≥0 to get

firm 2’s best response to p

1

.

Max u

2

(p

1

, p

2

)=(a – p

2

+ bp

1

)(p

2

– c)

subject to 0 ≤ p

2

≤ +

FOC: a + c – 2p

2

+ bp

1

= 0

p

2

= (a + c + bp

1

)/2

Firm 2’s best response,

R

2

(p

1

) = (a + c + bp

1

)/2

EEG-UM Microeconomia III 46

Sequential-move Bertrand model of

duopoly (differentiated products)

Solve firm 1’s problem. Note firm 1 can also solve firm

2’s problem. Firm 1 knows firm 2’s best response to p

1

.

Hence, firm 1’s problem is

Max u

1

(p

1

, R

2

(p

1

))=(a – p

1

+ b× ×× ×R

2

(p

1

) )(p

1

– c)

subject to 0 ≤ p

1

≤ +

That is,

Max u

1

(p

1

, R

2

(p

1

))=(a – p

1

+ b× ×× ×(a + c + bp

1

)/2 )(p

1

– c)

subject to 0 ≤ p

1

≤ +

FOC: a – p

1

+ b× ×× ×(a + c + bp

1

)/2+(–1+b

2

/2) (p

1

– c) = 0

p

1

= (a+c+(ab+bc–b

2

c)/2)/(2–b

2

)

JDIC (Mod1)

24

EEG-UM Microeconomia III 47

Sequential-move Bertrand model of duopoly

(differentiated products)

Subgame-perfect Nash equilibrium

((a+c+(ab+bc–b

2

c)/2)/(2–b

2

), R

2

(p

1

) ),

where R

2

(p

1

) = (a + c + bp

1

)/2

Firm 1 chooses a price

(a+c+(ab+bc–b

2

c)/2)/(2–b

2

),

firm 2 chooses a price R

2

(p

1

) if firm 1 chooses a

price p

1

.

- Daron Acemoglu - Coalition Formation in Political Games (2006)uploaded byNaos2015
- Mayzlin2006-Promotional_Chat_on_the_Internet.pdfuploaded bydanikapan
- Engendering Changeuploaded byJoshua Gans
- Lecture5_RepeatedGames(1)uploaded byJay Zhou
- Curnot Slidesuploaded byJames Hammond
- David E. Wallin 1992uploaded bynuruye
- International Jurnal of Strategic Managementuploaded byChristian Natanael
- Rationality and Bounded Rationalityuploaded byleovenu
- Bargaining in Stationary Networks 06-Libreuploaded bysuchi87
- GAME THEORYuploaded byMohamed
- Sophisticated Monetary Policiesuploaded byCervino Institute
- ssrn-id2885460 - Kopieuploaded byYavuz Topal
- CEPR-DP3123uploaded bycampan43
- EC319 Lecture 5uploaded byHitesh Rangra
- Game Theoryuploaded byKristian Kafazov
- A Trade Coalition Analysis on East Asian Free Trade Agreementuploaded byAlexander Decker
- UT Dallas Syllabus for eco7391.001.07f taught by Kevin Siqueira (kjs064000)uploaded byUT Dallas Provost's Technology Group
- Article-Competing for Shelf Spaceuploaded bysanits591
- Creed Experimentuploaded byBabak Zandi

Close Dialog## Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

Loading