Part 1: Introduction to Game Theory

Game theory: set of tools for the analysis of interactive decision making (conflict-
ing/mutual interests).

Many Applications: Economics, Political Science, Biology,...

We model such a situation (with interactive decision makers) by means of a strategic

game, which is defined by the following elements:

• The players

• The actions/strategies

• The payoffs

These three define the “rules of the game”.

{
- purposeful;
Important assumption: the players are rational →
- no indecision, no mistakes.

Given the rules of the game, the players optimize a goal expressed through their
payoffs.

Example 1 : Matching pennies

Player 2
Heads T ails
Heads − 1, +1 +1, −1
Player 1
T ails + 1, −1 −1, +1

• Penalty kick

• Land and Sea game

Objective: to determine the strategies that the players should play as well as the
outcome(s) that should arise.

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 Chapter I: Strategic games in normal form

Strategic games in normal form are used to model simultaneous-move games.

The main assumptions are:

• the players are all rational;

• the players all move at the same time;

• each player has complete knowledge of the structure of the game.

I-1 Definition and examples

Definition A strategic (or non-cooperative) game in normal form, in short a normal-
[ ]
form game, is given by a tuple Γ = I, (Si )i∈I , (ui )i∈I , where:

• I is the non-empty set of players.

• For each i ∈ I, Si is a non-empty set and is called player’s i strategy set (or action
set).

• For each i ∈ I, ui : S → IR is player i’s payoff function. The amount ui (s) is i’s
payoff (or utility) if the joint strategy s is played.

Example 2 : The Prisoner’s Dilemma

Prisoner 2
Quiet F ink
Quiet − 2, −2 −10, −1
Prisoner 1
F ink − 1, −10 −5, −5

The payoffs are ordinal (only the ranking of the joint strategies matters)

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Example 3 : Cournot Oligopoly (linear price and linear costs)

Consider n firms operating in the same market. The inverse demand is given by:
{
a − bQ if Q ≤ a/b
P (Q) =
0 if Q > a/b
∑n
where Q = i=1 qi is the total output produced and a, b > 0.

The (constant) marginal cost of production for firm i is ci (i = 1, ..., n).

 What outputs should the firms produce?

 Write in normal form

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 I-2 Solution concepts
 Dominated strategies
[ ]
Definitions Consider a game Γ = I, (Si )i∈I , (ui )i∈I

1- Player i’s strategy s̄i is weakly dominated if there exists another strategy ŝi ∈ Si
such that:
ui (s̄i , s−i ) ≤ ui (ŝi , s−i ), for any s−i ∈ S−i ,
with the strict inequality for at least one s−i .

• In case the inequality holds strictly for all s−i ∈ S−i , s̄i is said to be strictly
dominated (by ŝi ).
• It is also common to say that ŝi (strictly/weakly) dominates s̄i .

2- Player i’s strategy ŝi is a weakly dominant strategy if it weakly dominates all the
other strategies of i. That is, if for any s̄i ̸= ŝi , we have:

ui (ŝi , s−i ) ≥ ui (s̄i , s−i ), for any s−i ∈ S−i ,

with the strict inequality for at least one s−i .

In case ŝi strictly dominates all the other strategies of player i, we say that ŝi is a
strictly dominant strategy.

Example 2 : The Prisoner’s Dilemma

→ Iterated Deletion of Strictly Dominated Strategies (IDSDS)

Prisoner 2
Quiet F ink
Quiet − 2, −2 −10, −1
Prisoner 1
F ink − 1, −10 −5, −5

For each prisoner, the strategy Quiet is (weakly and strictly) dominated by Fink.
The outcome of the procedure IDSDS is thus ( Fink, Fink ).

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 → Iterated Deletion of Weakly Dominated Strategies (IDWDS)

Player 2
L C R
T 4, 2 2, 2 0, 0
Player 1 M 2, 4 6, 2 4, 2
B 4, −4 2, −2 −2, −2

No dominant strategy. For player, B is weakly dominated (by T). For player 2, R is
weakly dominated (by C).
The outcome depends on the order of deletion. Eliminating B first gives the unique
joint strategy (T, L) as the outcome of IDWDS.

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 Best responses and Nash equilibrium
[ ]
Consider a game Γ = I, (Si )i∈I , (ui )i∈I .

Definition
- For every s−i ∈ S−i , the strategy si ∈ Si is called a best response of player i against
s−i if we have:
ui (si , s−i ) ≥ ui (s′i , s−i ), for any s′i ∈ Si .

- The set of best responses of player i against s−i is denoted by Bi (s−i ) and the multi-
valued function Bi is called the best response correspondence of player i.

Remarks
1- Every element of Bi (s−i ) must solve the problem: max ui (s′i , s−i ).
s′i ∈Si

2- A dominant strategy of player i is necessarily a best response against any s−i ∈ S−i .

Definition
A Nash equilibrium of the game Γ is a joint strategy s∗ = (s∗i )i∈I ∈ S such that, for any
i ∈ I,
ui (s∗i , s∗−i ) ≥ ui (si , s∗−i ), for any si ∈ Si .

That is to say, for any player i, s∗i is a best response to s∗−i .

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  The Prisoner’s Dilemma (Example 2)

Prisoner 2
Quiet F ink
Quiet − 2, −2 −10, −1
Prisoner 1
F ink − 1, −10 −5, −5

(F ink, F ink) is NE.

 The Cournot model of duopoly (Example 3 with n = 2)

→ If q2 ≥ a−c
b
, check that firm 1’s best response is 0.

→ Fix q2 ∈ [0, a−c

b
). The best response of firm 1 against q2 , b1 (q2 ), must solve:

max [a − b(q1 + q2 ) − c]q1

q1 ≥0

→ Easy to rule out 0 (since q2 < a−c

b
), i.e. b1 (q2 ) > 0 and the FOC applies with
equality.
a − c q2
FOC: a − 2bq1 − bq2 − c = 0, i.e. q1 = −
2b 2

Hence, the best response function of firm 1 is:

{
a−c
2b
− q22 if q2 < a−cb
b1 (q2 ) =
0 if q2 ≥ b .
a−c

For firm 2,
{
a−c
2b
− q21 if q1 < a−cb
b2 (q1 ) =
0 if q1 ≥ a−c .
b {
q1 = b1 (q2 )
By solving the system of equations which defines the Nash equilibrium
q2 = b2 (q1 ),
∗
one obtains the Nash equilibrium q = ((a − c)/3b, (a − c)/3b).

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 I-3 Further illustrations of the Nash equilibrium (NE)

 The Cournot oligopoly (Example 3)

• The cost per unit is c > 0 for each of the n firms


 ∑n ∑
n

 a−b qj if qj ≤ a/b
• The inverse demand is: P (q1 , ...., qn ) = j=1 j=1
∑n


 0 if qj > a/b,
j=1

where a > c.
→The best response of firm i solves the profit maximization problem:


 ∑ ∑
n

 [a − b(qi + qj )]qi − cqi if qj ≤ a/b
j̸=i j=1
max πi (qi , q−i ) = ∑
n
qi ≥0 
 − cqi
 if qj > a/b,
j=1
∑ a−c
Similar to the case n = 2. For qj < b
, the FOC for firm i is
j̸=i
∑ a−c 1∑
a − 2bqi − b qj − c = 0, i.e. qi = − qj
j̸=i
2b 2 j̸=i

The best response function of firm i is therefore

 ∑ ∑

 2b − 2
a−c 1
qj if qj < a−c
b
j̸=i j̸=i
bi (q−i ) = ∑

 0 if qj ≥ a−c
.
b
j̸=i

→ Solving for the NE.

The n FOC give a system of n linear equations with n unknowns
∑
a − 2bqi − b qj − c = 0, for every i = 1, ..., n.
j̸=i

1. Solve the system

2. Symmetry (when the players/firms are identical).

Using the FOC and taking qi = qj for any two firms gives qi∗ = a−c
(n+1)b
. Thus the
NE q ∗ = ( (n+1)b
a−c a−c
, ..., (n+1)b ).

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  Auctions

Example 4: First-price, sealed-bid auction (complete information)

→ The players are the n bidders (n ≥ 2), with valuations v1 > v2 > ... > vn .

→ Each player i submits a bid bi , which is a nonnegative number: Si = [0, +∞).

→ The highest bidder wins the object and pays her bid to the seller. In case the
highest bid is submitted by many bidders, the object is allocated to the one with
the highest valuation.

→ The payoffs: if player i wins the object, her utility is vi − bi ; otherwise her utility
is 0.

There are many NE. One of them is (b1 , b2 ..., bn ) = (v2 , v2 , ..., vn )
→ No incentive for bidder 1 to deviate

– Choosing b1 < v2 would lose her the object (bidder 2 would win)
– Choosing b1 > v2 (against (b2 = v2 , ..., bn = vn )) would win her the object,
and result in the payoff v1 − b1 < v1 − v2

→ No incentive for bidder i = 2, 3, ..., n to deviate

– Choosing bi ≤ v2 (with bi ̸= vi ) would not affect bidder i’s payoff

– Choosing bi > v2 would win her the object, but result in a negative payoff

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 Example 5: Second-price, sealed-bid auction (complete information)

→ The players are the n bidders (n ≥ 2), with valuations v1 > v2 > ... > vn .

→ Each player i submits a bid bi , which is a nonnegative number: Si = [0, +∞).

→ The highest bidder wins the object. In case the highest bid is submitted by many
bidders, the object is allocated to the one with the highest valuation.

→ The payoffs: if player i wins the object, her utility is vi − max bj ; otherwise her
j̸=i
utility is 0.

One NE in this case is (b1 , b2 ..., bn ) = (v1 , v2 , ..., vn ).

In fact, bidding one’s valuation is a weakly dominant strategy in the second price
auction.

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 Figure 1: vi is the dominant bid for player i, b̄ = max bj
j̸=i

• Nash equilibrium: self-enforced, no incentives to deviate

• Multiple NE

Player 2
L M R
L 2, 2 0, 0 1, 0
Player 1 M 0, 0 −1, −1 0, 0
R 0, 1 0, 0 1, 1

B1 (L) = {L}, B1 (M ) = {L, R}, B1 (R) = {L, R}.

Two NE: (L, L) and (R, R) ⇒ NE selection

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• Existence might be a problem (Matching Pennies, Example 1)

Player 2
Heads T ails
Heads − 1, +1 +1, −1
Player 1
T ails +1, −1 −1, +1

No coincidence of best responses ⇒ no Nash equilibrium.

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I-4 Mixed strategies

Definitions and notation

Consider a game Γ = [I, (Si )i∈I , (ui )i∈I ]. We assume that the game Γ is finite (n players,
each having a finite strategy set).

1- A mixed strategy σi of player i is a probability distribution over Si . The weight given

∑
by σi to the strategy si ∈ Si is σi (si ), with σi (si ) = 1.
si ∈Si

If Si is constituted of m strategies, then a mixed strategy of player i is an m-tuple

σi = (p1 , ..., pm ) ∈ Rm
+ satisfying the property p1 + ... + pm = 1.

2- We denote by ∆(Si ) the set of mixed strategies of player i.

3- The concept of expected utility is used to extend the payoff function to mixed strategy
profiles. For any a mixed strategy profile σ = (σ1 , ..., σn ), the expected payoff of player
i is
∑
ui (σ) = σ1 (s1 )...σn (sn )ui (s)
s∈S

- Illustration with matching pennies and linearity of the payoff function

- From now on, any si ∈ Si will be called a pure strategy of player i.

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Definitions
[ ]
In what follows we consider the mixed extension I, (∆(Si ))i∈I , (ui )i∈I .

1- Player i’s mixed strategy σ̄i is strictly dominated if there exists another mixed
strategy σ̂i ∈ ∆(Si ) such that:

ui (σ̄i , σ−i ) < ui (σ̂i , σ−i ), for any σ−i .

2- Given any player i and any mixed strategy profile σ−i of the other players, a
strategy σi ∈ ∆(Si ) is called a best response of i against σ−i if it satisfies:

ui (σi , σ−i ) ≥ ui (σi′ , σ−i ), for any σi′ ∈ ∆(Si ).

Bi (σ−i ) is the set of best responses of i against σ−i .

3- A mixed strategy profile σ ∗ is a mixed strategy Nash equilibrium of Γ if, for every
player i, σi∗ is a best response of i against σ−i
∗
.

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Example: Best responses for Matching Pennies

→ Best response of player 1, B1 (q), against qH + (1 − q)T (for q ∈ [0, 1])

• q = 1/2 u1 (H, 12 H + 21 T ) = 0 = u1 (T, 21 H + 12 T ). Thus, any σ1 ∈ ∆(S1 ) is a

best response against q = 1/2.

• q < 1/2 u1 (H, qH + (1 − q)T ) = q u1 (H, H) +(1 − q) u1 (H, T ) = −q + (1 − q) =

| {z } | {z }
=−1 =+1
1 − 2q > 0
u1 (T, qH + (1 − q)T ) = q u1 (T, H) +(1 − q) u1 (T, T ) = q − (1 − q) =
| {z } | {z }
=+1 =−1
2q − 1 < 0
Thus, B1 (q) = {H}.

• q > 1/2 u1 (H, qH + (1 − q)T ) = 1 − 2q < 0

u1 (T, qH + (1 − q)T ) = 2q − 1 > 0
Thus, B1 (q) = {T }.

→ One can do thesame for player 2 in order to derive B2 (p).


 {1}, 

 if q < 1/2  {0}, if p < 1/2

In summary, B1 (q) = {p : 0 ≤ p ≤ 1}, if q = 1/2 B2 (p) = {q : 0 ≤ q ≤ 1}, if p = 1/2

 

 {0}, if q > 1/2  {1}, if p > 1/2.

Figure 2: Matching Pennies, best responses

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We will say that a game Γ = [I, (Si )i∈I , (ui )i∈I ] is finite if I is finite and Si is finite for
any i ∈ I.

 PROPOSITION (Existence of mixed strategy NE for finite games) p. 252 in MWG

Every strategic game in normal form that is finite has a mixed strategy Nash equilibrium.

Remarks:
1- Finiteness of the game is important (a game that is infinite may have no NE)
2- There may be many mixed strategy NE.
3- The NE mentioned in the proposition might be constituted of pure strategies, even if
it is the only one.

How can one check that a given strategy profile is a mixed strategy Nash equilibrium?
The following proposition provides the answer.

 PROPOSITION (Characterization of mixed strategy NE for finite games) p. 250

A mixed strategy profile σ ∗ = (σ1∗ , ..., σn∗ ) is a mixed strategy Nash equilibrium if and
only if, for each player i, we have the following two:

• every pure strategy si ∈ Si which is given positive probability by σi∗ yields the
∗ ∗
same expected payoff against σ−i , that is to say ui (si , σ−i ) = ui (σ ∗ );

• every pure strategy si ∈ Si which is given zero probability by σi∗ yields no more
∗
than the pure strategies that are assigned positive probability: ui (si , σ−i ) ≤ ui (σ ∗ ).

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EXAMPLE
Consider the 2x3 matrix game

Player 2
L C R
T 4, 2 0, 1 −1, −2
Player 1
B 4, −2 0, 1 −1, 2

→ (T, L) and (B,R) are pure strategy NE

→ Next, we check that σ ∗ = ( 21 T + 12 B, C) is a mixed strategy NE

For player 1: σ1∗ = 12 T + 12 B (T and B with positive probabilities), σ−1

∗
= C.

We have u1 (T, C) = 0 = u1 (B, C) = u1 (σ ∗ ).

For player 2: σ2∗ = C (only C with positive probability), σ−2

∗
= 12 T + 12 B.

We have u2 ( 12 T + 21 B, C) = 12 u2 (T, C) + 21 u2 (B, C) = 1

| {z } | {z }
=1 =1
u2 ( 12 T + 12 B, L) = 12 u2 (T, L) + 12 u2 (B, L) = 0
| {z } | {z }
=2 =−2
u2 ( 12 T + 12 B, R) = 12 u2 (T, R) + 12 u2 (B, R) = 0.
| {z } | {z }
=−2 =2

σ ∗ = ( 12 T + 12 B, C) is therefore a mixed strategy NE.

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 Definitions
1- An n-player game in normal form is symmetric if S1 = S2 = ... = Sn and the n players
all have the same payoff function u(si , s−i ).

2- A profile σ of mixed strategies is symmetric if σi is the same for every player i.

The Prisoner’s Dilemma (Example 3)

Prisoner 2
Quiet F ink
Quiet − 2, −2 −10, −1
Prisoner 1
F ink − 1, −10 −5, −5

 PROPOSITION
Every finite, symmetric game in normal form has a symmetric mixed strategy Nash
equilibrium.

Remarks:
1-The symmetric NE may be in pure strategies.
2- There may be other asymmetric NE too.

Example:
Player 2
A B
A 2, 2 4, 3
Player 1
B 3, 4 2, 2

The game is symmetric. The only pure strategy NE are (A, B) and (B, A) (neither of
them is symmetric)

→ Check that ( 23 A + 31 B, 32 A + 13 B) is symmetric mixed strategy NE of this game.

18