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Rationalizablity & Backwards

Induction

14.12 Game Theory

Muhamet Yildiz

Road Map

1. Cournot (quantity) Competition

1. Nash Equilibrium in Cournot duopoly

2. Nash Equilibrium in Cournot oligopoly

3. Rationalizability in Cournot duopoly

2.

3.

4.

5.

6.

Commons Problem

Quiz

Mixed-strategy Nash equilibrium

Backwards induction

Cournot Oligopoly

N = {1,2,,n} firms;

Simultaneously, each firm i

produces qi units of a good at

marginal cost c,

and sells the good at price

P = max{0,1-Q}

where Q = q1++qn.

Game = (S1,,Sn; 1,,n)

where Si = [0,),

P

1

-qic

otherwise.

qj=0.2

Profit

c=0.2

0

qi(1- qi -qj-c)

-cqi

-0.2

(1-qj-c)/2

1-qj-c

qiB(qj)

q2

= max{(1-qj-c)/2,0};

q1* = (1-q2*-c)/2;

q2* = (1-q1*-c)/2;

q1* = q2* = (1-c)/3

q1=q1B(q2)

q*

1 c

2

q2=q2B(q1)

q1

1-c

q>1-c is strictly dominated, so q 1-c.

i(q1,,qn) = qi[1-(q1++qn)-c] for each i.

FOC: ( q ,K, q )

[ qi (1 q1 L qn c )]

i

n

1

qi

q=q

qi

q = q*

That is,

q1* + 2q2* + L + qn* = 1 c

M

q1* + q2* + L + nqn* = 1 c

Therefore, q1*==qn*=(1-c)/(n+1).

P

n=1

n=2

n=3

n=4

c

1

q2

1-c

Assume that

players are

rational.

1 c

2

q1

1 c

2

1-c

q2

1-c

Assume that

players know

this.

1 c

2

q1

1 c

2

1-c

that players are rational

q2

1-c

Assume that

players know

this.

1 c

2

q1

1 c

2

1-c

are rational; players know that players know

that players

are rational

q

2

1-c

Assume that

players know

this.

1 c

2

q1

1 c

2

1-c

If i knows that qj q, then qi (1-c-q)/2.

If i knows that qj q, then qi (1-c-q)/2.

We know that qj q0 = 0.

Then, qi q1 = (1-c-q0)/2 = (1-c)/2 for each i;

Then, qi q2 = (1-c-q1)/2 = (1-c)(1-1/2)/2 for each i;

qn+1 = (1-c-qn)/2 = (1-c)(1-1/2+1/4-+(-1/2)n)/2.

As n, qn (1-c)/3.

N = {1,2} firms.

Simultaneously, each firm i sets a price pi;

If pi < pj, firm i sells Q = max{1 pi,0}

unit at price pi; the other firm gets 0.

If p1 = p2, each firm sells Q/2 units at price

p1, where Q = max{1 p1,0}.

The marginal cost is 0.

if p1 < p2

p1 (1 p1 )

1 ( p1 , p2 ) = p1 (1 p1 ) / 2 if p1 = p2

otherwise.

0

Theorem: The only Nash equilibrium in the Bertrand

game is p* = (0,0).

Proof:

1. p*=(0,0) is an equilibrium.

2. If p = (p1,p2) is an equilibrium, then p = p*.

1. If p = (p1,p2) is an equilibrium, then p1 = p2...

2. Given any equilibrium p = (p1,p2) with p1 = p2, p = p*.

Commons Problem

N = {1,2,,n} players, each with unlimited

money;

Simultaneously, each player i contributes xi

0 to produce y = x1+xn unit of some

public good, yielding payoff

Ui(xi,y) = y1/2 xi.

Stag Hunt

(2,2)

(4,0)

(0,4)

(5,5)

What is a strategy?

A complete contingent-plan of a player.

What the others think the player might do under

various contingency.

The player is randomly choosing his pure

strategies.

The other players are not certain about what he

will do.

Stag Hunt

(2,2)

(4,0)

(0,4)

(5,5)

Assume: Player 2 thinks that,

with probability p, Player 1

targets for Rabbit. What is the

best probability q she wants to

play Rabbit?

His payoff from targeting

Rabbit:

U2(R;p) = 2p + 4(1-p)

= 4-2p.

From Stag:

U2(S;p) = 5(1-p)

She is indifferent iff

4-2p = 5(1-p) iff p = 1/3.

5

4.5

4

3.5

3

2.5

4 - 2p

2

1.5

1

5(1-p)

0.5

0

0.2

0.4

0.6

0.8

if p < 1/3

0

q ( p ) = q [0,1] if p = 1/3

1

if p > 1/3

BR

q

1/3

p

1/3

10

N = {F1,F2,B}; F1, F2

are firms; B is buyer

B needs 1 unit of good,

worth 6;

Firms sell the good;

Marginal cost = 0.

Possible prices P =

{1,5}.

Buyer can check the

prices with a small cost

c > 0.

Game:

1. Each firm i chooses price

p i;

2. B decides whether to

check the prices;

3. (Given) If he checks the

prices, and p1p2, he buys

the cheaper one;

otherwise, he buys from

any of the firm with

probability .

search

F2

F1

F2

High

Low

F1

High

High

Low

Low

Check

High

Low

Dont Check

11

Mixed-strategy equilibrium

Symmetric equilibrium: Each firm charges

High with probability q;

Buyer Checks with probability r.

U(check;q) = q21 + (1-q2)5 c = 5 - 4 q2 c;

U(Dont;q) = q1 + (1-q)5 = 5 - 4 q;

Indifference: 4q(1-q) = c; i.e.,

U(high;q,r) = 0.5(1-r(1-q))5;

U(low;q,r) = qr1 + 0.5(1-qr)

Indifference = r = 4/(5-4q).

Information

&

Backward Induction

12

Definitions

Perfect-Information game is a game in which all

the information sets are singleton.

Sequential Rationality: A player is sequentially

rational iff, at each node he is to move, he

maximizes his expected utility conditional on that

he is at the node even if this node is precluded

by his own strategy.

In a finite game of perfect information, the common

knowledge of sequential rationality gives

Backward Induction outcome.

A centipede game

1

D

(4,4)

(5,2)

(1,-5)

d

(3,3)

13

Backward Induction

Take any pen-terminal node

Pick one of the payoff vectors (moves) that

gives the mover at the node the highest payoff

Assign this payoff to the node at the hand;

Eliminate all the moves and the

terminal nodes following the node

Yes

Any non-terminal

node

No

The picked moves

1

2

L

(2,1)

2

R

(0,0)

(0,0)

(1,2)

14

Note

There are Nash equilibria that are different

from the Backward Induction outcome.

Backward Induction always yields a Nash

Equilibrium.

That is, Sequential rationality is stronger

than rationality.

1

Head

Tail

head

tail

(-1,1)

(1,-1)

head

(1,-1)

tail

(-1,1)

15

Stackelberg Duopoly

Game:

P

N = {1,2} firms w MC = 0;

1. Firm 1 produces q1 units

1

2. Observing q1, Firm 2 produces

q2 units

3. Each sells the good at price

P = max{0,1-(q1+q2)}.

Q

1

0

otherwise.

Stackelberg equilibrium

If q1 > 1, q2*(q1) = 0.

If q1 1, q2*(q1) = (1-q1)/2.

Given the function q2*, if q1 1

P

1

= q1 (1-q1)/2;

0 otherwise.

q1* = .

q2*(q1*) = .

16

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