Module 4-6 in 1

Week 4: Sustaining cooperation 4.
1 Group rationality and the rationality of

individuals
One of the most important messages of Game Theory One of the most important messages of Game Theory
What is good for society
3 4
What is good for society What is good for each individual What is good for society What is good for each individual
Cooperation
5 6
Cooperation You may be tempted to shirk Cooperation You may be tempted to shirk
Keep it clean!
7 8
Keep it clean! But, …..
9 10
Stop global warming! Stop global warming! But, …..
11 12
Group rationality
13 14
One of the most important messages of Game Theory Prisoner’s Dilemma
What is good for society What is good for each individual

2 Cooperate Defect
Group rationality Rationality of individuals 1
Cooperate
Defect
15 16
Prisoner’s Dilemma Prisoner’s Dilemma
2 Cooperate Defect 2 Cooperate Defect

1 1
Cooperate -1, -1 Cooperate -1, -1
Defect Defect -10, -10
17 18

1 1
Cooperate -1, -1 Cooperate -1, -1 -15, 0
Defect 0, -15 -10, -10 Defect 0, -15 -10, -10
19 20

1 1
Cooperate -1, -1 -15, 0 Cooperate -1, -1 -15, 0
Defect 0, -15 -10, -10 Defect 0, -15 -10, -10

Nash equilibrium Nash equilibrium
Individual rationality
21 22

1 1
Cooperate -1, -1 -15, 0 Cooperate -1, -1 -15, 0
Defect 0, -15 -10, -10 Defect 0, -15 -10, -10

Individual rationality Group rationality Individual rationality
23 24
Prisoner’s Dilemma
Group rationality
2 Cooperate Defect
1
Cooperate -1, -1 -15, 0
Defect 0, -15 -10, -10

Nash equilibrium
Group rationality Individual rationality
25 26
B’s payoff
Formal definition?
Group rationality
Possible payoffs A’s payoff
27 28
B’s payoff B’s payoff

How can we define an outcome that is “best for society”? It is easer to define a point that is not the best for society.
Possible payoffs A’s payoff Possible payoffs A’s payoff
29 30
Obviously not the best for the society of A and B …
31 32

Obviously not the best for the society of A and B … Obviously not the best for the society of A and B …
…. because we can make both A and B happier
33 34

Not the best for society either …
35 36
Not the best for society either …
…. because we can make A happier without
making B less happy
37 38

There is no better point for society
It is possible to make It is possible to make

society better society better
39 40

The best points for society
41 42
“What is best for society” is not a single point
The best points for society
“What is best for society”

is not a single point.
43 44
“What is best for society” is not a single point “What is best for society” is not a single point
B’s payoff … and the best points for society are called
B’s payoff … and the best points for society are called
“Efficient outcomes”
45 46
Game theory shows that the following is quite often true: Game theory shows that the following is quite often true:
Best points for society
47 48
Efficient outcomes Efficient outcomes

Best points for society Best points for society
Group rationality
49 50
Efficient outcomes Efficient outcomes

Group rationality Group rationality
Nash equilibrium Nash equilibrium Rationality of individuals
51 52
Efficient outcomes
Group rationality “Inefficiency” of Nash equilibrium
Nash equilibrium Rationality of individuals Nash equilibrium
53 54
“Inefficiency” of Nash equilibrium “Price of anarchy”

in economics in computer science
55 56
“Price of anarchy” “Price of anarchy”

in computer science in computer science
Maximum total payoff Maximum total payoff

Nash equilibrium
Total payoff at Nash equilibrium
Nash equilibrium
Total payoff at Nash equilibrium >1
57 58
4.2 Why is group rationality different from 4.2 Why is group rationality different from
rationality of individuals? rationality of individuals?
Why is Nash equilibrium often inefficient?
59 60
Group rationality
61 62
Group rationality Rationality of individuals Group rationality Rationality of individuals
Nash equilibrium
63 64
One of the most important messages of Game Theory A puzzle

Group rationality Rationality of individuals
Efficient outcome Nash equilibrium
65 66
A puzzle A puzzle
a a b
A’s payoff A’s payoff B’s payoff
67 68
A puzzle A puzzle
When individuals maximize their payoffs…
a + b = a + b a + b = a + b
A’s payoff B’s payoff Society’s payoff A’s payoff B’s payoff Society’s payoff
69 70
A puzzle A puzzle
When individuals maximize their payoffs… When individuals maximize their payoffs…
a + b
A’s payoff B’s payoff
a + b = a + b = a + b
A’s payoff B’s payoff Society’s payoff Society’s payoff
71 72
A puzzle A puzzle
When individuals maximize their payoffs… Why isn’t society’s payoff also maximized? When individuals maximize their payoffs…
a + b = a + b Nash equilibrium Best outcome for society
A’s payoff B’s payoff Society’s payoff
73 74
A puzzle A puzzle
When individuals maximize their payoffs… When individuals maximize their payoffs… Why isn’t society’s payoff also maximized?
Nash equilibrium Best outcome for society Nash equilibrium Best outcome for society
Two main reasons Two main reasons
75 76
Reason #1 Reason #1
a + b = a + b a + b = a + b
A’s effort alone cannot create benefit
77 78
Reason #1 Reason #1
a
A’s payoff
+ b = a + b a + b = a + b
B’s payoff Society’s payoff A’s payoff B’s payoff Society’s payoff
A’s effort alone cannot create benefit A’s effort alone cannot create benefit
79 80
Reason #1 Reason #1
+ b
B’s payoff
a + b = a + b a = a + b
A’s payoff B’s payoff Society’s payoff A’s payoff Society’s payoff
B’s effort alone cannot create benefit B’s effort alone cannot create benefit
81 82
Reason #1 Reason #1
a + b = a + b a + b = a + b
B’s effort alone cannot create benefit
83 84
Reason #1 Reason #1
a + b a + b
A’s payoff B’s payoff A’s payoff B’s payoff
= a + b = a + b
Society’s payoff Society’s payoff
They can create benefit only if they act together
85 86
Reason #1 Reason #1
a + b = a + b
They can create benefit only if they act together Players can create benefit only if they act together
87 88
Reason #1 Reason #1
Society may be trapped

in a bad Nash equilibrium
Players can create benefit only if they act together Players can create benefit only if they act together
89 90
Reason #1 Reason #1
Society may be trapped Society may be trapped

in a bad Nash equilibrium in a bad Nash equilibrium
“Coordination failure”
Players can create benefit only if they act together Players can create benefit only if they act together
91 92
Reason #2 Reason #2
Your effort alone cannot create benefit
93 94
Reason #2 Reason #2
Benefit of good behavior may not come to you
But ….
can create social benefit can create social benefit
Your effort alone cannot create benefit Your effort alone cannot create benefit
95 96
Reason #2 Reason #2
Benefit of good behavior may not come to you Benefit of good behavior may not come to you
a + b a + b
A’s payoff B’s payoff A’s payoff B’s payoff
I scratch your back
97 98
Reason #2 Reason #2
Each individual may not have an incentive to cooperate
+ b + b
a a
A’s payoff A’s payoff
I scratch your back I scratch your back
99 100
Reason #2 Reason #2
Each individual may not have an incentive to cooperate
+ b + b
B’s payoff
= a + b B’s payoff
= a + b
a Society’s payoff
a Society’s payoff
A’s payoff A’s payoff
I scratch your back I scratch your back You scratch my back
101 102
Reason #2 Reason #2
But if they both cooperate, they may be better-off
a + b a + b = a + b
A’s payoff B’s payoff
= a + b
Society’s payoff
I scratch your back You scratch my back I scratch your back You scratch my back
103 104
Reason #2 Reason #2
Rational individuals may not take socially desirable behavior
I scratch your back You scratch my back I scratch your back You scratch my back
105 106
Reason #2 Reason #2
Previous slides explained why society may be trapped in a bad point Previous slides explained why society may be trapped in a bad point
Now let us examine why good point may not be not sustainable
107 108
Reason #2 Reason #2
Cost of cheating may be paid by others Cost of cheating may be paid by others
a + b = a + b
109 110
Reason #2 Reason #2
a + b = a + b a + b = a + b
……. best for society
Stop global warming! Stop global warming!
111 112
Reason #2 Reason #2
a
a + b = a + b A’s payoff + b = a + b
A’s payoff B’s payoff Society’s payoff B’s payoff Society’s payoff
…Well, I may cheat …Well, I may cheat
113 114
Reason #2 Reason #2
a a
A’s payoff = a + b A’s payoff
Society’s payoff
= a + b
+ b + b Society’s payoff
…Well, I may cheat …Well, I may cheat
115 116
Reason #2 Reason #2
Rational individuals may want to cheat at the best point for Rational individuals may want to cheat at the best point for
society society
117 118
Reason #2 Reason #2
Rational individuals who maximize their own payoff ignore the Rational individuals who maximize their own payoff ignore the
effects to others effects to others
Rational individuals may not take good behavior that greatly benefits others,
if it is costly
119 120
Reason #2 Reason #2
Rational individuals may not take good behavior that greatly benefits others,
if it is costly
Rational individuals may take bad behavior that greatly harms others, if it is
profitable.
121 122
Reason #2 Reason #2
This is one of the most important reasons why maximization of each This is one of the most important reasons why maximization of each
individual payoff does not lead to maximization of society’s total payoff individual payoff does not lead to maximization of society’s total payoff
Nash equilibrium Best outcome for society
123 124
One of the most important messages of Game Theory
4.3 Group rationality vs. rationality of

individuals in biological evolution What is good for society What is good for each individual
125 126
Group rationality Group rationality Rationality of individuals
127 128
Nash equilibrium Efficient outcome Nash equilibrium
129 130
One of the most important messages of Game Theory Impact to evolutionary biology

Group rationality Rationality of individuals
Efficient outcome Nash equilibrium
Absent “strategic or game theoretic“ reasoning,
we tend to think that this would happen
131 132
Impact to evolutionary biology Impact to evolutionary biology
Old Idea Old Idea
Species A Species B Species C
133 134
Old Idea Old Idea
Species A Species B Species C
Maximum fitness Maximum fitness
135 136
Old Idea Old Idea
Evolution Evolution Maximum fitness of species
Maximum fitness Maximum fitness
137 138
Old Idea Old Idea
Evolution Maximum fitness of species Evolution Maximum fitness of species
Observed characteristics Observed characteristics

body size
139 140
Old Idea Old Idea
Evolution Maximum fitness of species Evolution Maximum fitness of species
Observed characteristics Observed characteristics

body size body size
behavior behavior “Wolves do not fight until they die.”
141 142
Old Idea New Idea
Evolution Maximum fitness of species
Observed characteristics
body size
behavior “Wolves do not fight until they die.”
were supposed to maximize the fitness of species
143 144
New Idea New Idea

In each species, a variety of genes play a game In each species, a variety of genes play a game
Successful genes have more offsprings
145 146
New Idea New Idea

In each species, a variety of genes play a game
Successful genes have more offsprings
Evolution leads to a Nash equilibrium
147 148
New Idea New Idea
Evolution Evolution Nash equilibrium of game

played by genes
149 150
New Idea New Idea
Evolution Nash equilibrium of game Evolution Nash equilibrium of game

played by genes played by genes
Cooperation C
Suppose genes play a game similar to Prisoner’s Dilemma Suppose genes play a game similar to Prisoner’s Dilemma
151 152
New Idea New Idea

Cooperation C Defection D
153 154
New Idea New Idea

Fitness of species appears to

be maximized
155 156
New Idea New Idea

mutants’ invasion
157 158
New Idea New Idea

159 160
New Idea New Idea

161 162
Impact to evolutionary biology
New Idea New Idea

played by genes played by selfish genes
Fitness of species may Fitness of species may

not be maximized ! not be maximized !
Suppose genes play a game similar to Prisoner’s Dilemma
163 164
Game theory has fundamentally changed the way we view biological evolution
4.4 Group rationality vs. rationality of

New Idea
individuals in social thought
Evolution Nash equilibrium of game
played by selfish genes
Fitness of species may

not be maximized !
165 166
Group rationality
167 168
Nash equilibrium
169 170
Efficient outcome Nash equilibrium Efficient outcome Nash equilibrium
Absent “strategic or game theoretic “reasoning,
we tend to think that this would happen
171 172
Impact to social thought Impact to social thought
Adam smith Adam smith
Rational pursuit of individual happiness leads to a socially optimal

outcome
173 174
Rational pursuit of individual happiness leads to a socially optimal Rational pursuit of individual happiness leads to a socially optimal
outcome in competitive markets outcome in competitive markets
“Invisible hand”
175 176
Market for used textbooks Market for used textbooks
Willing to pay up tp $80
177 178
$80 $80
Willing to pay up tp $80 Willing to pay up tp $80
Happy to sell if the price is above $20
179 180
$80 $80
Willing to pay up tp $80 Willing to pay up tp $80
Benefit created, if they trade
$20 $20
Happy to sell if the price is above $20 Happy to sell if the price is above $20
181 182
$80 $80
$70 $70
$20 $20
183 184
$80
$70 Minimum acceptable
price
$25
$20
Willingness to pay
185 186
Market for used textbooks Market Price
Maximum social benefit Maximum social benefit
Minimum acceptable
price
Willingness to pay
187 188
Market Price Market Price
Maximum social benefit Maximum social benefit
Supply Supply
Demand
189 190
Market Price
Maximum social benefit
Supply
 Market equilibrium
Demand
191 192
What is good for each individual What is good for society
193 194
Adam smith
What is good for each individual What is good for society What is good for each individual What is good for society
“Invisible hand” “Invisible hand”
195 196
This idea was once overgeneralized
in competitive markets in competitive markets
What is good for each individual What is good for society What is good for each individual What is good for society
“Invisible hand” “Invisible hand”
197 198
The idea of invisible hand was once overgeneralized The idea of invisible hand was once overgeneralized
199 200
The idea of invisible hand was once overgeneralized The idea of invisible hand was once overgeneralized
(1) If the present situation is not socially optimal (1) If the present situation is not socially optimal
(2) It is possible to make everyone happier
201 202
The idea of invisible hand was once overgeneralized
(1) If the present situation is not socially optimal
 (3) Rational individual must agree to make

everyone happier
203 204
205 206
(2) It is possible to make everyone happier (2) It is possible to make everyone happier
(3) Rational individual must agree to make everyone happier (3) Rational individual must agree to make everyone happier
Give rational individuals Best outcome in society

freedom to choose
207 208
Give rational individuals Best outcome in society Give rational individuals Best outcome in society
freedom to choose freedom to choose
Naïve social thought for †Laissez-faire
†Laissez-faire: The policy of leaving things to take their own course, without interfering:
From: Oxford Dictionaries
209 210
Around 1980, a number of conservative economists

forcefully advocated this idea
211 212
Liberal economists tried to refute this idea Liberal economists tried to refute this idea
Often times their argument was that people are not so rational
213 214

freedom to choose
Liberal economists tried to refute this idea

Often times their argument was that people are not so rational
Conservative economists were not convinced.
215 216
Throughout the 1980’s, game theory became a

dominant mode of research in economics
Game theory’s conviction
217 218
There is nothing wrong in (1) – (3).
Game theory’s conviction Game theory’s conviction
219 220
(3) Rational individual must agree to make everyone happier

But the agreement (3) may not be sustainable.
221 222
Best outcome for society is quite often
 not Nash equilibrium 
223 224
Individual may deviate from agreement (3) Rational individual must agree to make everyone happier

under Laissez-faire
This argument is wrong, because agreement (3) may not be sustainable.
225 226

(2) It is possible to make everyone happier freedom to choose
(3) Rational individual must agree to make everyone happier
This argument is wrong, because agreement (3) may not be sustainable.

Economists are now fully convinced that this

naïve idea is false
227 228
Stop global warming! But, …..
Reality
229 230
Impact to social thought
4.5 How to enforce socially desirable outcomes

freedom to choose
Game theory put an end to this naïve social thought.
231 232
4.5 How to enforce socially desirable outcomes

There are three general ways. Good point for society is often
not Nash equilibrium
Nash equilibrium
233 234
Good point for society is often Good point for society is often
 
not Nash equilibrium not Nash equilibrium
Individuals are tempted to

deviate
235 236
How can we sustain a good point for society? Three general ways to achieve a good outcome
 
237 238
Three general ways to achieve a good outcome Three general ways to achieve a good outcome
 (1) Change/design the rules of game  (1) Change/design the rules of game
(2) Use Legally binding contracts
239 240
(1) Designing system/institution/markets
Three general ways to achieve a good outcome
 (1) Change/design the rules of game

(2) Use Legally binding contracts
(3) Use Long-term relationship
241 242
(1) Designing system/institution/markets (1) Designing system/institution/markets
Game Theory Game Theory
Rules of game
243 244
Rules of game Outcome Rules of game Outcome
245 246
Good outcome Rules of game? Good outcome
247 248
Rules of game? Good outcome Rules of game? Good outcome
Design system/institution/trading rules carefully, Design system/institution/trading rules carefully, in such a way that
individuals have an incentive to achieve a good outcome
249 250
Game Theory Mechanism Design / Market Design
Rules of game Outcome
Mechanism Design / Market Design
Rules of game? Good outcome
Design system/institution/trading rules carefully, in such a way that

individuals have an incentive to achieve a good outcome
251 252
Mechanism Design / Market Design Mechanism Design / Market Design

Game theory has been applied to design real-life institutions Game theory has been applied to design real-life institutions
Matching young doctors to hospitals for on the job training
253 254

Matching young doctors to hospitals for on the job training Matching young doctors to hospitals for on the job training
Nobel Prize in Economics 2012
Alvin E. Roth Lloyd S. Shapley

Credit: Bengt Nyman, CC BY 2.0 Credit: Bengt Nyman, CC BY 2.0
255 256
Matching young doctors to hospitals for on the job training Matching young doctors to hospitals for on the job training
Matching students to public schools Matching students to public schools
Auction rules to sell spectrum bands to mobile phone companies
257 258
(2) Sign a legally binding contract (2) Sign a legally binding contract
to enforce a desirable outcome,
259 260
to enforce a desirable outcome, where individuals have an incentive to deviate to enforce a desirable outcome, where individuals have an incentive to deviate
Employment contract
261 262
to enforce a desirable outcome, where individuals have an incentive to deviate to enforce a desirable outcome, where individuals have an incentive to deviate
Employment contract Employment contract
Construction contract Construction contract
”Legally binding” contract is enforced by the court
263 264
to enforce a desirable outcome, where individuals have an incentive to deviate

Individuals have an incentive to cheat
Employment contract
Construction contract
”Legally binding” contract is enforced by the court

If contact is breached, penalty is imposed by the court
265 266
Individuals have an incentive to cheat Individuals have an incentive to cheat
Gain from cheating Gain from cheating
If contact is breached, penalty is imposed by the court
267 268
Gain from cheating Penalty Gain from cheating ≤ Penalty
If contact is breached, penalty is imposed by the court If contact is breached, penalty is imposed by the court
269 270
Gain from cheating ≤ Penalty Gain from cheating ≤ Penalty
Condition to sustain desirable outcome
271 272
However, we do not sign a legal contract so often.
Gain from cheating ≤ Penalty
Condition to sustain desirable outcome
“Incentive compatibility condition”
273 274
However, we do not sign a legal contract so often. However, we do not sign a legal contract so often.
Legal contract is costly Legal contract is costly

Writing a detailed contract
275 276

Writing a detailed contract Writing a detailed contract
Litigation when it is breached Litigation when it is breached
The court may be unable to observe if the right actions
were taken.
277 278

Writing a detailed contract Writing a detailed contract
Litigation when it is breached Litigation when it is breached
The court may be unable to observe if the right actions The court may be unable to observe if the right actions
were taken. were taken.
There may be no legal system to enforce a contract There may be no legal system to enforce a contract
Stop global warming! But, …..
279 280
(3) Use long-term relationship (3) Use long-term relationship
A less costly and more flexible alternative to legal contract
281 282
(3) Use long term relationship (3) Use long term relationship
Recall how a legal contract works Recall how a legal contract works
Individuals have an incentive to cheat
Gain from cheating
283 284
(3) Use long term relationship (3) Use long term relationship
Recall how a legal contract works Recall how a legal contract works
Gain from cheating Penalty Gain from cheating ≤ Penalty
If contact is breached, penalty is imposed by the court If contact is breached, penalty is imposed by the court
285 286
How long-term relationship works How long-term relationship works
If you cheat, you can gain today….
287 288
How long-term relationship works How long-term relationship works
If you cheat, you can gain today…. If you cheat, you can gain today….
… but your partner will penalize you in the future
289 290
(3) Use long-term relationship
We will see how it works in the next lecture 4.6 Cooperation of gas stations in long-term
relationship
If you cheat, you can gain today….
Gain from cheating ≤ Penalty
… but your partner will penalize you in the future
291 292
Gas stations at near-by locations
4.6 Cooperation of gas stations in long-term

relationship
Part I: Need for cooperation
293 294
Gas stations at near-by locations Gas stations at near-by locations
Prices posted every morning
Credit: Kikuya-Nakamura Credit: Kikuya-Nakamura
295 296
Prices posted every morning Prices posted every morning
Selling identical product (gasoline) Selling identical product (gasoline)
Different prices
297 298
Different prices All customers go to Different prices All customers go to

cheaper station cheaper station
Same prices
299 300
Different prices All customers go to Different prices All customers go to

cheaper station cheaper station
Same prices Customers are Same prices Customers are
split equally split equally
Same unit cost
301 302
Prices posted every morning
Selling identical product (gasoline) Price
Different prices All customers go to

cheaper station Demand
Same prices Customers are
split equally
Credit: Kikuya-Nakamura
Same unit cost (wholesale price of gas + labor …)
Cost $2
Quantity
303 304
Best outcome for gas stations Best outcome for gas stations
Price Price They charge a price that maximizes

their total profit
Demand Demand
Cost $2 Cost $2
Quantity Quantity
305 306
Price They charge a price that maximizes Price They charge a price that maximizes
their total profit their total profit
They split customers equally
Demand Demand
p1  p2 p1  p2
$3 $3
Total profit Total profit
Cost $2 Cost $2
Quantity Quantity
307 308
Price They charge a price that maximizes Price

their total profit
They split customers equally
Demand Demand
p1  p2 p1  p2
$3 $3
1’s profit 2’s profit
Total profit 1’s profit 2’s profit
Total profit
Cost $2 Cost $2
Quantity Quantity
309 310
Price Unfortunately, this situation is “unstable” Price Unfortunately, this situation is “unstable”
Gas station 1 can undercut the price slightly
Demand Demand
p1  p2 p1  p2
$3 $3
Total profit
Cost $2 Cost $2
Quantity Quantity
311 312
Gas station 1 can undercut the price slightly Gas station 1 can undercut the price slightly
Demand Demand
p1 p2 p1 p2
$3 $3
Total profit 1’s profit
Total 2’s profit
profit
1’s profit
Cost $2 Cost $2
Quantity Quantity
313 314
Gas station 1 can undercut the price slightly Gas station 1 can undercut the price slightly
and steal all customers from station 2 and almost double its profit
Demand Demand
p1 p2 p1 p2
$3 $3
1’s profit
Total 2’s profit
profit
Total 2’s profit
profit
1’s profit
Cost $2 Cost $2
Quantity Quantity
315 316
Best outcome for gas stations Not Nash equilibrium Best outcome for gas stations
Price They charge a price that maximizes Price They charge a price that maximizes
their total profit their total profit
They split customers equally They split customers equally
Demand Demand
p1  p2 p1  p2
$3 $3
Total profit
Cost $2 Cost $2
Quantity Quantity
317 318
Nash equilibrium of price competition Nash equilibrium of price competition
Price Price
Demand Demand
p1  p2
Each gets zero profit
Cost $2 Cost $2
Quantity Quantity
319 320
Nash equilibrium of price competition
No one can gain by deviating alone Total profit maximization What is good for each gas station
Price
Demand
p1  p2
Each gets zero profit
Cost $2
Quantity
321 322
Total profit maximization What is good for each gas station Total profit maximization What is good for each gas station
Group rationality Group rationality Rationality of individuals
323 324
Nash equilibrium of price competition predicts zero profit
325 326
They enjoy positive profits in reality They enjoy positive profits in reality
Why ? Credit: Kikuya-Nakamura
Nash equilibrium of price competition predicts zero profit Nash equilibrium of price competition predicts zero profit
327 328
This is true when they play the But in reality they play the price
price competition game only once competition game every day
Nash equilibrium of price competition predicts zero profit Nash equilibrium of price competition predicts zero profit
329 330
In their long-term relationship,

positive profits may be achieved
Nash equilibrium of price competition predicts zero profit
331 332
The same players The same players

Gas stations 1 and 2
333 334

Gas stations 1 and 2 Gas stations 1 and 2
play the same game play the same game

Price competition
335 336


Price competition Price competition
repeatedly repeatedly
Today, tomorrow, ……
337 338


Price competition Price competition
repeatedly repeatedly
Today, tomorrow, …… Today, tomorrow, ……
“Repeated Game” “Repeated Game”
A model of long-term relationship
339 340
The same players How do they sustain a high price

Gas stations 1 and 2
in long-term relationship?
play the same game
Price competition Stage game
repeatedly
Today, tomorrow, ……
“Repeated Game”
A model of long-term relationship
341 342
How do they sustain a high price How do they sustain a high price
in long-term relationship? in long-term relationship?
Plausible considerations Plausible considerations
I can undercut the price and

increase my profit today
343 344
How do they sustain a high price How do they sustain a high price
in long-term relationship? in long-term relationship?
I can undercut the price and I can undercut the price and
increase my profit today increase my profit today

But it may trigger cut-throat price But it may trigger cut-throat price
competition in the future competition in the future
That’s not good for me after all, so let me stick to the

high price
345 346
How do they sustain a high price 4.7 Cooperation of gas stations in long-term
in long-term relationship? relationship
Plausible considerations
I can undercut the price and

increase my profit today
But it may trigger cut-throat price
competition in the future
That’s not good for me after all, so let me stick to the

high price
347 348
4.7 Cooperation of gas stations in long-term A high price may be sustained

relationship in long-term relationship
Part II: Mechanism of cooperation
349 350
A high price may be sustained A high price may be sustained

in long-term relationship in long-term relationship
I can undercut the price and increase

my profit today
351 352
A high price may be sustained A high price may be sustained

in long-term relationship in long-term relationship
I can undercut the price and increase I can undercut the price and increase
my profit today my profit today

But it may trigger cut-throat price competition But it may trigger cut-throat price competition
in the future in the future
That’s not good for me after all, so let me stick to the high
price
353 354
A strategy in long-term relationship that A strategy in long-term relationship that

formalizes the plausible consideration formalizes the plausible consideration
Start with high price
355 356

Start with high price Start with high price

Keep on charging high price, Keep on charging high price,
if no one has deviated
357 358


if no one has deviated if no one has deviated
If anyone has deviated from high price, If anyone has deviated from high price,
set price equal to cost forever
359 360

If anyone has deviated from high price, If anyone has deviated from high price,
set price equal to cost forever set price equal to cost forever
In equilibrium, high price is maintained everyday
361 362

If anyone has deviated from high price, If anyone has deviated,
Deviation triggers cut-throat price competition “Trigger strategy”
363 364

cooperation Start with high price
cooperation

cooperating
If anyone has deviated, If anyone has deviated,
“Trigger strategy” “Trigger strategy”
365 366

cooperation
Keep on charging high price,

cooperating Keep on charging high price,
cooperating

Nash equilibrium of price competition game in one day
367 368

cooperation
Keep on charging high price,

cooperating Keep on charging high price,
cooperating
set price equal to cost forever play Nash equilibrium of stage game
forever

Nash equilibrium of the “stage game”
369 370
In general, trigger strategy works as follows: In general, trigger strategy works as follows:
Nash equilibrium
Stage Game
371 372
(1) In equilibrium, cooperate in every period (1) In equilibrium, cooperate in every period
A point that is better than
  stage game Nash equilibrium

for all players
Stage Game Stage Game
373 374
(1) In equilibrium, cooperate in every (1) In equilibrium, cooperate in every

period period
 (2) If anyone deviates, play Nash equilibrium  (2) If anyone deviates, play Nash equilibrium
of the stage game forever of the stage game forever
Stage Game Stage Game
375 376
Let us examine the condition for the trigger strategy to support cooperation Let us examine the condition for the trigger strategy to support cooperation
Cooperation
377 378
Let us examine the condition for the trigger strategy to support cooperation Let us examine the condition for the trigger strategy to support cooperation
Cooperation (charging a high price) Cooperation (charging a high price)
Each gas station gets $100 every day
379 380
A gas station’s payoff under trigger strategy A gas station’s payoff under trigger strategy
March 1 March 2 March 3 March 4 …….. March 1 March 2 March 3 March 4 ……..
Cooperation $100 $100 $100 $100 …….. Cooperation $100 $100 $100 $100 ……..
Defection
381 382
Defection Defection
By slightly undercutting the price, By slightly undercutting the price,

one can steal all customers from the other station
383 384
almost almost
Defection $200 Defection $200
By slightly undercutting the price,

one can steal all customers from the other station Gain from defection
385 386
almost almost
Defection $200 Defection $200
Gain from defection Gain from defection

$100 today
387 388
almost almost
Defection $200 $0 $0 $0 …….. Defection $200 $0 $0 $0 ……..
389 390
almost almost
Defection triggers cut-throat price competition

Future loss
391 392
almost almost
Future loss Future loss

$100 everyday $100 everyday
How do we evaluate this?
393 394
almost almost

$1 on Dec 31 is not as good as $1 today We discount future payoff
395 396
almost almost

Let d = the value of $1 tomorrow Let d = the value of $1 tomorrow
d < 1 (we discount future payoff)
397 398
almost almost

100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯
Let d = the value of $1 tomorrow Let d = the value of $1 tomorrow
d < 1 (we discount future payoff) d < 1 (we discount future payoff)
399 400
Future loss Today’s gain from defection Future loss

100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯ 100 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯
d = the value of $1 tomorrow d = the value of $1 tomorrow
401 402
Today’s gain from defection Future loss Today’s gain from defection Future loss
100 < 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯ 100 < 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯

Defection is not profitable under trigger strategy
403 404
In reality, d is almost equal to 1, and this condition is satisfied In reality, d is almost equal to 1, and this condition is satisfied
Today’s gain from defection Future loss Today’s gain from defection Future loss
100 < 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯ 100 < 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯

Trigger strategy sustains cooperation
405 406
Gas stations can cooperate and Gas stations can cooperate and
maintain a high price maintain a high price
by their long-term relationship
407 408
Restaurant in touristic place
4.8 Reputation and brand name
409 410
Restaurant in touristic place Restaurant in touristic place
Dinner Dinner
$50 $50
411 412
High quality ? High quality ?
Low quality ?
Dinner Dinner
$50 $50
413 414
High quality ? High quality ?
Low quality ? Low quality ?
You know the quality only after eating Hence, you may be cheated
Dinner Dinner
$50 $50
415 416
If you come to this place every day

High quality ?
Low quality ?
How can the restaurant assure high quality?
Dinner Dinner
$50 $50
417 418
If you come to this place every day If you come to this place every day
your trigger strategy may support high quality your trigger strategy may support high quality
Low quality
Dinner Dinner
$50 $50
419 420
If you come to this place every day If you come to this place every day
your trigger strategy may support high quality your trigger strategy may support high quality
Low quality
But you don’t come here so often
You never come back
Dinner Dinner
$50 $50
421 422
Restaurant in touristic place
If you come to this place every day

your trigger strategy may support high quality
This is a quite common situation

But you don’t come here so often
You cannot really “punish” the restaurant
Dinner
$50
423 424
You can observe quality of product/service only after buying You can observe quality of product/service only after buying
Hence, you may be cheated
This is a quite common situation This is a quite common situation
425 426
Hence, you may be cheated Hence, you may be cheated
You do not buy the same product/service so often You do not buy the same product/service so often
427 428
Restaurant Restaurant
Expensive clothes
429 430
Expensive clothes Expensive clothes
Car Car
House
431 432
Car Car
House House
Doctor for surgery Doctor for surgery
Lawyer for legal consulting
433 434
“Reputation” or “Brand name” can assure high quality

and prevent cheating
How do they assure high quality?
Car Car
House House
Lawyer for legal consulting Lawyer for legal consulting
435 436
How reputation works How reputation works
When restaurant has good reputation …
437 438
When restaurant has good reputation … When restaurant has good reputation …
customers believe high quality customers believe high quality
Dinner restaurant can charge high price

$50
439 440
When restaurant has good reputation … When restaurant has good reputation …
customers believe high quality customers believe high quality
Dinner restaurant can charge high price Dinner restaurant can charge high price
$50 $50
and earn high profit and earn high profit
Quality is actually high
441 442
When restaurant has good reputation … If the restaurant cheats
customers believe high quality
Dinner restaurant can charge high price Dinner

$50 $50
and earn high profit
Quality is actually high
Why ?
443 444
If the restaurant cheats If the restaurant cheats
What a disappointment ….
Dinner Dinner
$50 $50
445 446
If the restaurant cheats Restaurant loses good reputation
customers believe low quality

What a disappointment ….
Dinner
$50
… restaurant loses good reputation
447 448
Restaurant loses good reputation Restaurant loses good reputation
customers believe low quality customers believe low quality
restaurant can only charge low price restaurant can only charge low price
449 450
Restaurant loses good reputation Restaurant loses good reputation
and earn low profit and earn low profit
Quality is actually low
451 452
Restaurant loses good reputation Good reputation is lost
This is a dangerous self-sustaining

situation that restaurant wants to
avoid
Quality is actually low Quality is actually low

because restaurant has no reputation because restaurant has no reputation
to lose by providing low quality to lose by providing low quality
453 454
Good reputation is lost Good reputation is lost
Reputation or brand name is a Reputation or brand name is a

valuable asset valuable asset that assures high
quality and high profit
Quality is actually low Quality is actually low

because restaurant has no reputation because restaurant has no reputation
to lose by providing low quality to lose by providing low quality
455 456
The basic mechanism of reputation is similar to trigger strategy The basic mechanism of reputation is similar to trigger strategy
Suppose …. Suppose ….
Gain from cheating Gain from cheating Future profit is reduced by

$250 today $250 today $100 everyday
457 458
Today’s gain from cheating Today’s gain from cheating Future loss
250 250 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯
d = the value of $1 tomorrow
459 460
Today’s gain from cheating Future loss Today’s gain from cheating Future loss
250 < 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯ 250 < 100𝑑 + 100𝑑 2 + 100𝑑 3 + ⋯

If this condition holds, reputation mechanism assures high quality/high
profit
461 462
Today’s gain from cheating < Future loss Today’s gain from cheating < Future loss
In long-term relationship, punishment is given

by the person who was cheated
463 464
Today’s gain from cheating < Future loss Today’s gain from cheating < Future loss
In reputation mechanism, punishment is given In reputation mechanism, punishment is given

by future customers by future customers
Information transmission (about reputation) is a

substitute for long-term relationship
465 466
Summary Summary
Quality matters a lot You cannot verify quality before buying
Car Car
House House
467 468
Summary Summary
Sellers with good reputation or brand name earn extra profit

You may be cheated …
Car Car
House House
469 470
Summary
4.9 Cooperation in loosely knit organization

Sellers with good reputation or brand name earn extra profit
Their incentive to maintain this valuable asset assures high quality
Restaurant
Expensive clothes
Car
House
Doctor for surgery
Lawyer for legal consulting
471 472
Cooperation has been associated with closely knit group/organization Cooperation has been associated with closely knit group/organization
Individuals know each other well
473 474
Individuals know each other well Individuals know each other well
They stay in the group for a long time They stay in the group for a long time
Credit: Ministry of Land, Infrastructure, Transport and Tourism

1993 ANNUAL REPORT ON THE TRANSPORT ECONOMY
475 476
Villagers help each other to maintain the Villagers help each other to maintain the
roofs of their houses roofs of their houses Shirakawa-go
village in Japan
Credit: Ministry of Land, Infrastructure, Transport and Tourism Credit: Ministry of Land, Infrastructure, Transport and Tourism
1993 ANNUAL REPORT ON THE TRANSPORT ECONOMY 1993 ANNUAL REPORT ON THE TRANSPORT ECONOMY
477 478
Villagers help each other to maintain the

roofs of their houses Shirakawa-go
village in Japan
We saw that the theory of repeated games
explains cooperation in a closely knit group
Credit: Ministry of Land, Infrastructure, Transport and Tourism Credit: Ministry of Land, Infrastructure, Transport and Tourism
1993 ANNUAL REPORT ON THE TRANSPORT ECONOMY 1993 ANNUAL REPORT ON THE TRANSPORT ECONOMY
479 480
Received idea in Sociology Received idea in Sociology
A sociologist and I collaborated to show: A sociologist and I collaborated to show:
Cooperation in a loosely-knit organization
481 482
Cooperation in a loosely-knit organization Cooperation in a loosely-knit organization

Individuals enter and exit frequently Individuals enter and exit frequently
They do not know each other well
483 484

They do not know each other well They do not know each other well
They stay for a short time They stay for a short time
is not only theoretically possible,
485 486

They do not know each other well They do not know each other well
They stay for a short time They stay for a short time
is not only theoretically possible, but also there is a remarkable real-life example is not only theoretically possible, but also there is a remarkable real-life example
M. Kandori and S. Obayashi (2014) “Labor union members play an OLG

repeated game”, Proceedings of the National Academy of Science
487 488
Theory of cooperation in loosely-knit organization Theory of cooperation in loosely-knit organization
OLG repeated game
489 490
Overlapping Generations Overlapping Generations
OLG repeated game OLG repeated game
491 492
Overlapping Generations Overlapping Generations
A player
Time Time
493 494
Real-life
Theory example in loosely-knit organization
of cooperation Real-life
of cooperation
Cooperation
495 496
Real-life
of cooperation Real-life
of cooperation
Reward Reward
Cooperation Cooperation
Cramer (1986), Kandori (1992), Smith (1992)
497 498
Real-life example Real-life example
“Community Unions”
499 500
Community Union
Labor unions with quite unusual form
“Community Unions”
501 502
Individual-affiliate labor union Individual-affiliate labor union

Community Union Community Union
503 504

Community Union
Labor dispute Labor dispute
505 506

Labor dispute Labor dispute
A single worker of
a firm can join
507 508
Individual-affiliate labor union

A typical life of a member
Community Union
Community Union
Labor dispute
A single worker of
a firm can join
509 510
A typical life of a member A typical life of a member
Dispute Dispute
Entry
511 512
Dispute Dispute
Entry Entry
Union-firm Union-firm
negotiation negotiation
513 514
Dispute Dispute
Entry Entry
negotiation Protest activities negotiation Protest activities
515 516
Dispute Dispute
Entry Entry
Litigation Litigation
Labor Relations
Commission
517 518
Dispute Dispute
Entry Entry Exit
Union-firm
Resolution Union-firm
Resolution
Litigation Litigation
Labor Relations Labor Relations
Commission Commission
519 520
A typical life of a member
1 – 2 years
Dispute
Entry Exit
Union-firm
Resolution
negotiation Protest activities
Litigation
Labor Relations
Commission
521 522
A case study: Tokyo Managers’ Union A case study: Tokyo Managers’ Union
231 members (2012)
523 524

A case study: Tokyo Managers’ Union A case study: Tokyo Managers’ Union
231 members (2012) 231 members (2012)
Frequent entry and exit Frequent entry and exit
Fiscal year
2012 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Total
Entry 9 8 7 13 11 11 15 11 5 6 3 6 105
Exit 3 6 7 4 4 9 2 9 4 6 6 48 108
525 526

A case study: Tokyo Managers’ Union
The union closely resembles the OLG repeated game model.
231 members (2012)
Frequent entry and exit
Fiscal year
2012 Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Total
Entry 9 8 7 13 11 11 15 11 5 6 3 6 105
Exit 3 6 7 4 4 9 2 9 4 6 6 48 108
Average stay: 1.92 years
Time
527 528
1 – 2 years
The union closely resembles the OLG repeated game model.
1.92 years Entry Exit
Union-firm Resolution
Labor Relations
Commission
Litigation
Time We found that members help each other here
529 530
Real-life example
1 – 2 years How is cooperation sustained in the union?
Entry Exit
Union-firm Resolution
Labor Relations
Commission
Litigation
Typically, 5-20 members come to help
531 532
How is cooperation sustained in the union? How is cooperation sustained in the union?
Helping the old
533 534
Reward/Penalty by younger
generation
Helping the old Not helping
535 536
“Trigger strategy”
Everyone stop helping Everyone stop helping
Not helping Not helping
537 538

Everyone stop helping
Not observed in the union Not observed in the union
Not helping
539 540

Not observed in the union Not observed in the union
Theory of repeated games show that there are many other ways to sustain Theory of repeated games show that there are many other ways to sustain
cooperation cooperation
The challenge is to find out the mechanism used in this union
541 542
“Reputation mechanism” “Reputation mechanism”
Helping the old
543 544
“Reputation mechanism” “Reputation mechanism”
Reward by younger generation
Good reputation Good reputation
Helping the old Helping the old
545 546
How is cooperation sustained in the union?
“Reputation mechanism” The main difficulty

Not observed in the union
Reward by younger generation
Good reputation
Helping the old
547 548
The main problem The main problem
Not helping
549 550
This can be interpreted in two different ways
551 552
Yellow player is defecting Yellow player is defecting
Should be punished
553 554
Yellow player is punishing a defector
555 556
Yellow player is punishing a defector
Should not be punished
557 558
Defecting ? Defecting ?
Punishing a defector?
559 560
Defecting ? Younger players in the union typically Defecting ? Younger players in the union typically
Punishing a defector? Punishing a defector?
do not know which is true do not know which is true
Finding out how to sustain cooperation in such a situation is

a challenging theoretical problem
Not helping
561 562
Defecting ? Younger players in the union typically Defecting ? Younger players in the union typically
Punishing a defector? Punishing a defector?
do not know which is true do not know which is true
Finding out how to sustain cooperation in such a situation is Finding out how to sustain cooperation in such a situation is
a challenging theoretical problem a challenging theoretical problem
Based on an interview of a member, we discovered a clever equilibrium Based on an interview of a member, we discovered a clever equilibrium
strategy that can function well in such a situation strategy that can function well in such a situation
See the paper (publicly available at PNAS web site)
563 564
1. Game theory provides a governing principle that can be applied to
4.10 Summary of the course all social problems
565 566
1. Game theory provides a governing principle that can be applied to 1. Game theory provides a governing principle that can be applied to
all social problems all social problems
Credit: DonkeyHotey, CC BY Credit: DonkeyHotey, CC BY
Credit: Cacophony, CC BY-SA 3.0 Credit: Cacophony, CC BY-SA 3.0
567 568
By the same mathematical

reason that a vortex point exists
on coffee surface….
569 570
… game theory shows that

any social problem has a
point where players are doing
their best against others

Nash equilibrium
571 572
Players are doing their best

against others
Nash equilibrium
573 574
Any social problem can be formulated Any social problem can be formulated
as a mathematical model of as a mathematical model of
Game
(1) Players
(2) Strategies
(3) Payoffs
575 576
Any social problem can be formulated Any social problem can be formulated
as a mathematical model of as a mathematical model of
Game Game
(1) Players (1) Players
(2) Strategies (2) Strategies
(3) Payoffs (3) Payoffs
Credit: Cacophony, CC BY-SA 3.0 Using the power of math, game Credit: Cacophony, CC BY-SA 3.0 Using the power of math, game
theory finds out theory finds out
Nash equilibrium
This is a “stable situation “ where each
player can no longer improve his/her payoff
577 578
2. Nash equilibrium may emerge by a variety of reasons 2. Nash equilibrium may emerge by a variety of reasons
Intelligence of players
Hyper rationality Low rationality Zero-intelligence

Extremely sophisticated
reasoning
579 580
I know that you know that I know

that …. we are rational
Intelligence of players Intelligence of players
Hyper rationality Low rationality Zero-intelligence Hyper rationality Low rationality Zero-intelligence
Extremely sophisticated Extremely sophisticated
reasoning reasoning
581 582
Trial and error adjustment
reasoning reasoning
583 584
Trial and error adjustment
reasoning reasoning
585 586
Biological evolution
Intelligence of players Credit: Cacophony, CC BY-SA 3.0 Intelligence of players Credit: Cacophony, CC BY-SA 3.0
reasoning reasoning
587 588
3. Prediction power of game theory varies across applications 3. Prediction power of game theory varies across applications
Card game
589 590
Good fit
Card game Card game
Penalty kick Penalty kick
591 592
Good fit Good fit

Card game Card game
Traffic allocation Traffic allocation Reasonable fit
593 594
Good fit Good fit

Card game Card game
Traffic allocation Reasonable fit Traffic allocation Reasonable fit
Policy choice Policy choice

“Exactly the same policy”
595 596
3. Prediction power of game theory varies across applications 4. Prediction power of game theory is not perfect, but it is useful
Good fit
Card game
Penalty kick
Traffic allocation Reasonable fit
Policy choice Not exactly…..

597 598
4. Prediction power of game theory is not perfect, but it is useful 4. Prediction power of game theory is not perfect, but it is useful
Policy choice Not exactly….. Policy choice Not exactly…..

“Exactly the same policy” “Exactly the same policy”
Game theory provides useful insights
599 600
Policy choice Not exactly….. Policy choice Not exactly…..

“Exactly the same policy” “Exactly the same policy”
Game theory provides useful insights Game theory provides useful insights
Parties are tempted to choose similar policies Parties are tempted to choose similar policies
to steal voters from the opponent to steal voters from the opponent
Game theory provides useful benchmark
601 602
Policy choice Not exactly…..

Game theory provides useful insights

Parties are tempted to choose similar policies
to steal voters from the opponent
Game theory provides useful benchmark

If parties are not choosing the same policy, why is that…?
603 604
There is no reason to believe that people always come to play Nash equilibrium There is no reason to believe that people always come to play Nash equilibrium
But stylized facts are likely to be Nash equilibria
605 606
There is no reason to believe that people always come to play Nash equilibrium There is no reason to believe that people always come to play Nash equilibrium
But stylized facts are likely to be Nash equilibria But stylized facts are likely to be Nash equilibria
Stable mode of behavior Stable mode of behavior

that is repeatedly observed that is repeatedly observed
607 608
5. One of the most important messages: there is a conflict between 5. One of the most important messages: there is a conflict between
group rationality and rationality of individuals group rationality and rationality of individuals
609 610
Stop global warming!
611 612
Stop global warming! But, ….. Stop global warming! But, …..
Game theory shows how we can possibly overcome this problem
613 614

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Week 4: Sustaining cooperation 4.

1 Group rationality and the rationality of

What is good for society

Keep it clean! But, …..

Stop global warming! Stop global warming! But, …..

One of the most important messages of Game Theory Prisoner’s Dilemma

What is good for society What is good for each individual

Prisoner’s Dilemma Prisoner’s Dilemma

2 Cooperate Defect 2 Cooperate Defect

Cooperate -1, -1 Cooperate -1, -1

Defect Defect -10, -10

2 Cooperate Defect 2 Cooperate Defect

Cooperate -1, -1 Cooperate -1, -1 -15, 0

Defect 0, -15 -10, -10 Defect 0, -15 -10, -10

Prisoner’s Dilemma Prisoner’s Dilemma

2 Cooperate Defect 2 Cooperate Defect

Cooperate -1, -1 -15, 0 Cooperate -1, -1 -15, 0

Defect 0, -15 -10, -10 Defect 0, -15 -10, -10

Prisoner’s Dilemma Prisoner’s Dilemma

2 Cooperate Defect 2 Cooperate Defect

Cooperate -1, -1 -15, 0 Cooperate -1, -1 -15, 0

Defect 0, -15 -10, -10 Defect 0, -15 -10, -10

Individual rationality Group rationality Individual rationality

Cooperate -1, -1 -15, 0

Defect 0, -15 -10, -10

Group rationality Individual rationality

Possible payoffs A’s payoff

B’s payoff B’s payoff

Possible payoffs A’s payoff Possible payoffs A’s payoff

Possible payoffs A’s payoff Possible payoffs A’s payoff

B’s payoff B’s payoff

Possible payoffs A’s payoff Possible payoffs A’s payoff

B’s payoff B’s payoff

Possible payoffs A’s payoff Possible payoffs A’s payoff

Possible payoffs A’s payoff Possible payoffs A’s payoff

B’s payoff B’s payoff

It is possible to make It is possible to make

Possible payoffs A’s payoff Possible payoffs A’s payoff

B’s payoff B’s payoff

Possible payoffs A’s payoff Possible payoffs A’s payoff

“What is best for society”

Possible payoffs A’s payoff Possible payoffs A’s payoff

Possible payoffs A’s payoff Possible payoffs A’s payoff

Best points for society

Efficient outcomes Efficient outcomes

Efficient outcomes Efficient outcomes

Group rationality Group rationality

Nash equilibrium Nash equilibrium Rationality of individuals

Group rationality “Inefficiency” of Nash equilibrium

Nash equilibrium Rationality of individuals Nash equilibrium

Best points for society Best points for society

“Inefficiency” of Nash equilibrium “Price of anarchy”

Nash equilibrium Nash equilibrium

Best points for society Best points for society

“Price of anarchy” “Price of anarchy”

Maximum total payoff Maximum total payoff

One of the most important messages of Game Theory A puzzle

What is good for society What is good for each individual

When individuals maximize their payoffs…

a + b = a + b Nash equilibrium Best outcome for society

A’s payoff B’s payoff Society’s payoff

Two main reasons Two main reasons