MICROECONOMICS FOR PLANNERS

Lecture 15 Game Theory and Strategic Thinking: Problems and Opportunities

Professor Albert Saiz

10/28/2013

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Microeconomics

Game Theory

Logical analysis of goal-oriented behavior in strategic (interdependent) situations with limited allocation of resources or outcomes

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and identifying strategies and choices. and why they might do that. when motivation or objectives are inter-dependent. • Insights into what organizations (or individuals) might do in the realworld situation we are modeling.Microeconomics The Big Picture Game Theory • A method for analyzing decisions. • Practical examples: • Failures of coordination • “Anti-social” outcomes • • • • • Pre-emptive behavior: first mover advantage Facilitating Cooperation Among Local Agents Credibility of threats or promises in negotiations Strategic bidding in auctions Panics. Multiple equilibria and policy outcomes 3 .

In a sequential game. or unspecified number of rounds. We focus on non cooperative games where you are individually playing with other agents and each pursues his/her own objectives (i. Single period v repeated games.Microeconomics Types of games Cooperative v non cooperative. 4 . A game can be played just once then ends. the players choose action at the same time without observing each other’s moves. Repeated games are the topic of next class.e. one party moves and the other party observes what the first has done before taking an action. or it may be repeated for a specific. In a simultaneous game. “PAYOFFS” CAN INCLUDE ALTRUISTIC CONSIDERATIONS Simultaneous v sequential. payoff).

5 left Player 2 moves left 15. 2 These are simply two different ways of depicting the SAME game 5 2 does not know of 1’s action here! .Microeconomics Two Illustrations of a Simultaneous Single Period Game Extensive Form (tree) 10. 0 Player 1 moves up Payer 1 moves down 10 6 5 8 Player 2 moves right 15 20 0 2 Normal Form 2 Up right 1 Down left right 6. 8 2 20.

parties move at the same time. 2nd payoff value in cells shows their payoff In simultaneous games. but each knows the payoffs to themselves and to their rival in each cell Player 2 moves left Player 1 moves up Payer 1 moves down 10 6 5 8 Player 2 moves right 15 20 0 2 Could use non-numerical payoff but that just complicates notation! 6 . • Player 1 chooses rows.Microeconomics Reading a Game Matrix for a Simultaneous Move Game Conventions for summarizing payoffs in a game matrix • Cells show the players’ payoffs for that combination of choices . first payoff value in cells shows their payoff • Player 2 choose columns.

Purpose: Not (just) to “solve” a game. Sensitivity of predictions to our assumptions (about others’ sophistication. Motivations/objectives of players. 4. 3. regardless of what the other player does. what they know. to understand: 1. the motivations.Microeconomics About Analyzing Games A solution to a game can be a prediction of how rational players would act • • • Assumptions of common knowledge and rationality (objectives) Nash solution: Each chooses an optimal strategy. etc. How complex the whole strategic situation is. rather. 5. 2. given what the other player actually does (“mutual no regrets”) Dominance solution: A special case where some strategies can be ruled out. How important or valuable is communication in strategic situations 7 . How to identify ways to act (in reality) that will “change the game” to get better outcomes.).

course of action) that is worse for the player regardless of what other players do 8 .Microeconomics Dominant Strategy Dominant Strategy A strategy (choice. course of action) that is better for the player regardless of what other players do Dominated Strategy A strategy (choice.

000 workers to the local economy minus opportunity cost of incentives measured in worker-equivalent • Start with Tennessee’s decision KY incentives TN incentives TN no incentives 10 6 KY no incentives 0 2 5 15 8 10 9 .Dominant Strategy Equilibrium Simplest equilibrium • Both parties have a dominant strategy Microeconomics • Two adjacent state economic development teams (KY. and TN) deciding on preparing a package of benefits to attract firms • Gains measured in 1.

Microeconomics Dominant Strategy Equilibrium Equilibrium when only one player has a dominant strategy • TN can ANTICIPATE that KY will provide incentives • Therefore TN’s best strategy is also to provide incentives KY incentives TN incentives TN no incentives 10 6 KY no incentives 0 7 10 5 15 6 8 .

thinking when you need to • Think logically about the decisions you can make • Many decisions will be dominated: never a good idea under any circumstances • Do not ever consider dominated strategies: discard them and never look back • When thinking strategically it is of key importance to put yourself in the position of the other agents 11 .Microeconomics Over-thinking when you shouldn’t.

35 7.2 6.1 8.0 $1. 4 14 .65 10 .6 5.35 $1.Microeconomics Iterative Dominance Wallet-Get Tar-Mart Prices $1 $1.5 Tar-Mart dominant/dominated strategies? 12 .65 $1 3.2 $1.1 6. 7 8.

Microeconomics Iterative Dominance Wallet-Get Prices Tar-Mart $1 $1.2 6.6 5.35 => Remove row 1 from game. 7 8.65 $1 3.65 10 .5 Tar-Mar would never price at “$1” because it is dominated by a price of $1.0 $1.1 6.1 8.35 7. 4 14 . 13 .2 $1.35 $1.

2 $1.65 14 .1 6.Microeconomics Wallet-Get Prices Tar-Mart $1 5.35 8.0 $1.5 $1.2 6.65 • Now there is a dominant strategy equilibrium: 14 .35 $1. 7 8.

Microeconomics What if there are no dominant or dominated strategies? Then have to look at each cell in the matrix and see if someone wants to deviate from the current situation If they are “locked” into a situation they cannot individually disengage from: Nash equilibrium If they are happy to disengage individually: not a Nash equilibrium! 15 .

5) 16 Labor Day ( 10 . and Concerts Somerville 4th of July 4th of July Cambridge Labor Day ( 10 . Parade.Microeconomics Festivity Date: a pure coordination game Recall Nash equilibrium: everyone is responding optimally to other’s choice. 10 ) (5. Fireworks. 10 ) (5.5) Value of Talk? .

3) ( 5 . 15 ) ( 15 .3) Value of Talk? 17 .Microeconomics Coordination game with one best outcome Somerville 4th of July Labor Day 4th of July Cambridge Labor Day (3. 5 ) (3.

5 ) 4th Labor Somerville Labor (3.Microeconomics Sequential Games: One Player has the First Move 4th Somerville 4th Labor ( 5 .3) Cambridge ( 15 . 15 ) (3.3) 18 .

Microeconomics Sequential Games: keys to play • In 2-stage sequential games the first mover typically has the advantage • Have to substantiate talk with some kind of credible commitment: first to make commitment wins • Need to “play” the logic of the game backwards • Anticipate the best response of the other party to your moves • Make your move taking into account their best response! • Chess player mindset: predict motivations and behavior 19 .

rather than mandate outcome just allow Cambridge to have first choice!!! .3) 20 If you do not know better than the locals (almost always the case).3) ( 15 . 5 ) (8. 6 ) ( 30 .Microeconomics Coordination game with heterogeneity and regulators What should state government do? What if they do not know what is relative best for which. but do know that Cambridge gains and losses are greater? Somerville 4th of July Labor Day 4th of July Cambridge Labor Day (8.

Microeconomics What if you even don’t know who benefits more from choice? • Then “auction” out the right to pick first • Explicit or implicit trade-offs • For instance. it could be that Somerville would prefer to be first in choosing alternative policy • Compensations can make everyone better-off 21 .

and Westown in Biotech. strategic differentiation raises policy benefits!!! So… Does it help we know each others’ comparative advantage? How about communication? 22 . 2 1. –3 What is/are the Nash solution(s)? • Here. 1 5.Microeconomics Coordination Games 2: relative positioning Strategic Positioning: Cost-benefit of investments in economic development two major regional cities Westown Biotech IT Biotech Eastown IT –3. Eastown has a comparative advantage in IT. 5 2.

does that change how you might play? 23 . 10 10. 0 0. –5 0.Microeconomics “Chicken” Games Two adjacent municipal governments are considering major development plans in alternative sites (perhaps a large commercial space) Dounton New Development Undeveloped Upton New Development Undeveloped –5. 0 • What would you choose? • What is/are the Nash solution(s)? • Is talk useful? • If you repeat the game.

10 dev. no development Dounton no dev.Microeconomics Sequential Games: One Player has the First Move dev. 0 –5. –5 Upton 0. 0. 10. Dounton development no dev. 0 24 .

-20 -5. -1 -1.Microeconomics Individual Rationality Against Collective Outcomes Prisoner’s Dilemma Prisoner 2 Confess Quiet Confess -10. -10 -20. -5 Prisoner 1 Quiet • What is the Nash solution? 25 .

the contestants get a few minutes to talk.com/watch?v=hbS_1s985NA&feature=player_embedded . 26 • • http://www. Each contestant can choose to “split” or “steal”. presumably to convince the opponent that they plan to “split”. then each one gets 50% of the jackpot. And if both people steal. the person who steals gets the full jackpot and the other person gets 0.youtube. then they both get 0.Microeconomics Golden Balls Game Theory in Practice: Split or Steal • Split or Steal: Last round in British game show in which two contestants play a game similar to the Prisoner's Dilemma for the game’s jackpot. If one player splits and the other steals. Before playing. If both players “split”.

but remains at ~45% even for the highest stakes games.Strategies How do people behave? i) Contestants' propensity to choose “split” (or “cooperate”) decreases with the stakes. iv) Young males are less cooperative than young females. 27 . People who have an occupational interest in a cooperative and trustworthy reputation show smaller decreases in cooperation if the stakes increase.Microeconomics Split or Steal . but this gender effect disappears when age increases. ii) iii) Contestants are less likely to cooperate if their opponent has tried to vote them off the show in the first two rounds of the game.

1000-250=750 400+200= 600 .Microeconomics Note that we can have such outcomes happen even with altruistic motivations Prisoner’s Dilemma Develop NO Advertisement No Ad Revitalize Detroit Advertisement No Ad 500+250-250= 500.000 million • Cost of advertisement is 250 • Satisfaction for the NGO=1/2 of net revenues • What is the Nash solution? 28 . 500+250-250=500 1000-250= 750. 400+200=600 Two NGOs who invest in central cities • Donors will contribute 1. 0+375=375 0+375= 375 .

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