Slides 2020 in Use

Part IIA, Paper 1
Game Theory, Welfare, and

Applications.
Matthew Elliott
Cambridge
September, 2020
Some Logistics
My office hour is Wednesday (7.15-8.15pm) via
Teams.
You have, or will be given soon, printed handouts.
Spare copies are available.
Everything, including slides and a recording of the
lectures, is on Moodle.
Please do your best to attend lectures live and ask
questions via text.
I I’ll periodically stop and review questions.
I More interaction will make the lecture much more
entertaining and interesting.
I I normally rely on seeing puzzled faces to know when I’m
being unclear.
Road Map
About 16 lectures on game theory and applications.

I Simultaneous move games: Solution concepts,
randomization, lots of applications.
I Sequential move games: Solution concepts, lots of
applications.
Then 3-4 lectures on social choice and welfare.

I Binary choices.
I More than two choices.
Outline
1 Game Theory: Strategic Thinking
Introduction
Nash Equilibria
Applications: Nash equilibria
Dominant Actions
Applications: Dominant Actions
Iterated Deletion of Strictly Dominated Actions
Applications: Iterated Deletion of Strictly Dominated Actions
Additional Applications
2 Game Theory: Mixing Moves
3 Game Theory: Dynamic Games
4 Social Choice and Welfare

Game Theory: Main Texts
Everything you need to know is in provided material.
Supplementary Readings
Osborne and Rubinstein. “Models in microeconomic theory.” Chapters
15-16 Succinct presentation of the main key ideas. Some more advanced
material too.
Osborne, Martin. “An introduction to game theory.” Chapters 1-7 Slow
but comprehensive coverage
Dixit, Avinash K., and Barry J. Nalebuff. “Thinking strategically: The
competitive edge in business, politics, and everyday life.” Fun bedtime
reading.
Tirole, Jean. “The theory of industrial organization.” Advanced coverage
of IO applications
Gibbons, Robert. “A primer in game theory.” Introductory material—not
advanced enough to rely solely on
Kreps, David M, “Game theory and economic modelling,” Oxford
University Press, 1990. Nice conceptual overview.
Outline
Introduction
Nash Equilibria
Dominant Actions

What is Game Theory?
Strategic decision making.
Whenever agents’ preferred choices depend on
others’ choices.
Agents: people, firms, governments, politicians, . . . .
Choices: Military actions, firm pricing, political

platforms, bids on ebay, sports, board games,
What is Game Theory?
Strategic decision making.
Whenever agents’ preferred choices depend on
others’ choices.
Agents: people, firms, governments, politicians, . . . .
Choices: Military actions, firm pricing, political

platforms, bids on ebay, sports, board games, even
your choice about whether to attend the live stream
or watch the recording, . . . .
Use logical (mathematical) reasoning to guide our
thinking and provide insights.
What is Economics
Before 1950 when game theory took off, an acceptable

definition of economics would be
“a specialized social science concerned with the
production and allocation of material goods.”
What is Economics
Before 1950 when game theory took off, an acceptable

definition of economics would be
“a specialized social science concerned with the
production and allocation of material goods.”
Now, economists define their field as being about

“the analysis of incentives.”
Myerson (1999).
Questions we’ll be able to think about
On the Brexit negotiations:
What difference does it make that the UK had to
get agreement from all EU member countries?
How could uncertainty about what they might have
been willing to accept affected the UK’s bargaining
position?
Who should you get to bargain on your behalf?
What impact might separating the trade deal part
of the negotiations have had?
...
On business decisions:
Is a price matching “never knowingly undersold”
commitment good for consumers?
Should a board appoint a CEO that will maximize
profits or empire build?
When are mergers good for consumers?
...
Regarding the response to the virus:

Individual decisions to stockpile.
Vaccination choices of individuals.
Coordination of restrictions across areas/countries.
Issues around the development of a vaccine.
Regarding the response to the virus:

Individual decisions to stockpile.
Vaccination choices of individuals.
Coordination of restrictions across areas/countries.
Issues around the development of a vaccine.
and many more areas.
Good Modeling
Abstracts from the details, distilling some notion of

its essence and providing insights.
Formulating a good and useful model is an art
rather than a science.
But once formulated, the analysis is logical and
mathematical. This part is more scientific.
Example: Maps
Notation
Set of Players N = {1, . . . , n}, indexed i.
Each player has a set of possible actions Ai .
Actions ai ∈ Ai
Action profiles a = (a1 , a2 , . . . , an ) ∈ A.
So what is A?
Players choose their actions simultaneously (for
now).
Preferences over action profiles i . Transitive and
complete.
Notation
Example:
N = {1, 2}
Ai = {Q, F } for i = 1, 2
A = {(Q, Q), (F, F ), (Q, F ), (F, Q)}
(F, Q) 1 (Q, Q) 1 (F, F ) 1 (Q, F )
(Q, F ) 2 (Q, Q) 2 (F, F ) 2 (F, Q)
Notation
Simultaneous move strategic game described by tuple:
( |{z}
N , {Ai }i∈N , {i }i∈N )
| {z } | {z }
Players Action sets for all Preferences for all
Preferences are ordinal. They tell us preference
orderings.
They are not cardinal. They don’t tell us how much
people care.
Can represent preferences by a payoff function or
utility function ui : A → R such that a0 i a if and
only if ui (a0 ) ≥ ui (a).
But many different utility functions represent the
same preferences.
Example 1
By convention:
row player is Player 1
column player is player 2
And Payoffs have the form: (1’s payoff, 2’s payoff)
Player 2
Heads Tails
Heads 1, −1 −1, 1
Player 1
Tails −1, 1 1, −1
What is the game? Known in the literature as matching
pennies.
Modeling a strategic Situation
A private house has been robbed.

Two suspects seen on the grounds just prior.
Sufficient evidence for trespassing, but not burglary.
Police put them into different interrogation rooms.
Suspects can keep quiet or fink (confess).
Is this enough information to formulate the game?

A private house has been robbed.

Two suspects seen on the grounds just prior.
Sufficient evidence for trespassing, but not burglary.
Police put them into different interrogation rooms.
Suspects can keep quiet or fink (confess).
Is this enough information to formulate the game? No.

Prisoner’s Dilemma
Player 2
Quiet Fink
Quiet
Player 1
Fink
Police offer both suspects the following deal, shown for
player 1.
If 1 finks and 2 keeps quiet, (F, Q), no charge;
Both keep quiet, (Q, Q), trespassing charge;
If both fink (F, F ), burglary charge but reduced
sentence for cooperating;
If 1 keeps quite and 2 finks, (Q, F ), burglary charge.
player 1.
Now can we formulate the game?

player 1.
Now can we formulate the game? Yes, if we assume

that:
no charge i trespassing i reduced sentence i burglary
As players have the same preference orderings, we can
represent their preferences with four quantities a, b, c, d.
Player 2
Quiet Fink
Quiet a, a b, c
Player 1
Fink c, b d, d
What do we know about the relative magnitudes of

a, b, c, d?
As players have the same preference orderings, we can
represent their preferences with four quantities a, b, c, d.
Player 2
Quiet Fink
Quiet a, a b, c
Player 1
Fink c, b d, d
What do we know about the relative magnitudes of

a, b, c, d?
c>a>d>b
For Example:
Player 2
Quiet Fink
Quiet 2, 2 0, 3
Player 1
Fink 3, 0 1, 1
Describe this game
Player 2
Left Right
Up 4, −2 1, 0
Player 1
Down 3, 1 −10, 10
Describe this game
Player 2
Left Right
Up 4, −2 1, 0
Player 1
Down 3, 1 −10, 10
N =2
A1 = (Up, Down); A2 = (Left, Right)
(U, L) 1 (D, L) 1 (U, R) 1 (D, R)
(D, R) 2 (D, L) 2 (U, R) 2 (U, L)
Describe this game
Player 2
Left Right
Up 4, −2 1, 0
Player 1
Down 3, 1 −10, 10
N =2
A1 = (Up, Down); A2 = (Left, Right)
(U, L) 1 (D, L) 1 (U, R) 1 (D, R)
(D, R) 2 (D, L) 2 (U, R) 2 (U, L)
Familiar?
Relabel Actions
Player 2
Quiet Fink
Fink 4, −2 1, 0
Player 1
Quiet 3, 1 −10, 10
N =2
A1 = (Fink, Quiet); A2 = (Quiet, Fink)
(F, Q) 1 (Q, Q) 1 (F, F) 1 (Q, F)
(Q, F) 2 (Q, Q) 2 (F, F) 2 (F, Q)
Another representation of the Prisoners’ Dilemma.
Basketball or Soccer
Player 2
Basketball Soccer
Basketball 2, 1 0, 0
Player 1
Soccer 0, 0 1, 2
Stag Hunt
Player 2
Stag Hare
Stag 2, 2 0, 1
Player 1
Hare 1, 0 1, 1
Outline
Introduction
Nash Equilibria
Dominant Actions

Towards a Solution Concept
Want a way to analyze these games, and predict
how people will play.
Non-strategic environments: let people pick the
action that maximized their utility.
We’d expect people to choose an action:
a∗i ∈ argmax ui (ai ).

ai ∈Ai
But now i’s utility also depends on j’s actions.

If we hold i’s choice fixed and then change j’s
action, i’s action might no longer be best.
Enter Nash
Nash’s idea
Define an action profile in which all players are

simultaneously making optimal choices as an equilibrium.
So in a Nash Equilibrium:
ui (a) ≥ ui (a0i , a−i ) for all a0i ∈ Ai and for all i.
Players must be playing mutual best responses.

Prisoners’ Dilemma
Find the Nash equilibria.
Player 2
Quiet Fink
Quiet 2, 2 0, 3
Player 1
Fink 3, 0 1, 1
Prisoners’ Dilemma
Can represent best responses with arrows.
Player 2
Q F
Q 
2 0
 
Player 1 y 2−→
y 3
F 3 1
0−→1
Nash equilibria are all cells with no arrows exiting.
Stag Hunt
Player 2
Stag Hare
Stag 2, 2 0, 1
Player 1
Hare 1, 0 1, 1
Stag Hunt
Player 2
S H
S x
2 0
 
Player 1  2←−
y 1
H 1 1
0−→1
Player 2
Basketball Soccer
Basketball 2, 1 0, 0
Player 1
Soccer 0, 0 1, 2
Player 2
B S
B x
2 0
 
Player 1  1←−
y 0
S 0 1
0−→2
Matching Pennies
Player 2
Heads Tails
Heads 1, −1 −1, 1
Player 1
Tails −1, 1 1, −1
Matching Pennies
Player 2
H T
H x
1 0
 
Player 1  0−→
y 1
T 0 1
1←−0
Formalising Best Responses
If players other than i play actions a−i , how do we
mathematically describe i’s best response?
Issue: i’s best response may not be single valued.
Many actions may be be equally good.
Formalising Best Responses
If players other than i play actions a−i , how do we
mathematically describe i’s best response?
Issue: i’s best response may not be single valued.
Many actions may be be equally good.
Need best response correspondences (i.e. set valued
functions).
Bi (a−i ) = {ai ∈ Ai : ui (ai , a−i ) ≥ ui (a0i , a−i )

for all a0i ∈ Ai }.
An action profile a∗ is a NE if and only if for all i ∈ N ,

a∗i ∈ Bi (a∗−i ).
Nash Equilibria: A discussion
Is this a good way to predict how people play?
Nash Equilibria: A discussion
Is this a good way to predict how people play?
A Nash equilibrium requires everyone to correctly
anticipate what everyone else will do, and to then
play optimally.
How do people know what others are going to do?
Why should people correctly anticipate this?
Not restrictive enough: Multiple may exist.
Too restrictive: May not exist.
Can you come up with a more compelling solution
concept?
Outline
Introduction
Nash Equilibria
Dominant Actions

Baress’ Paradox
4 players need to travel from A to B.
Journey times depend on how many people use a
given route.
Find a Nash equilibrium.
6, 9, 12, 15
A X 20, 20.9, 21.8, 22.7
20, 21, 22, 23

6, 9, 12, 15
Y B
Baress’ Paradox
Suppose players 1 and 2 take route AXB.
While players 3 and 4 take route AY B.
1 and 2 have journey times of 29.9
3 and 4 have journey times of 30
Is there a profitable deviation?
Baress’ Paradox
Suppose players 1 and 2 take route AXB.
While players 3 and 4 take route AY B.
1 and 2 have journey times of 29.9
3 and 4 have journey times of 30
Is there a profitable deviation? No.
6, 9, 12, 15
A X 20, 20.9, 21.8, 22.7
20, 21, 22, 23

6, 9, 12, 15
Y B
Baress’ Paradox
To alleviate congestion suppose we build the road

XY .
How does the equilibrium change?
6, 9, 12, 15
A X 20, 20.9, 21.8, 22.7
20, 21, 22, 23

6, 9, 12, 15
Y B
Baress’ Paradox
To alleviate congestion suppose we build the road

XY .
How does the equilibrium change?
6, 9, 12, 15
A X 20, 20.9, 21.8, 22.7
7,
8,
9,
20, 21, 22, 23 10
6, 9, 12, 15
Y B
Baress’ Paradox
Suppose
1 takes route AXB.
2 takes route AY B.
3 takes route AXY B.
4 takes route AXY B.
6, 9, 12, 15
A X 20, 20.9, 21.8, 22.7
7,
8,
9,
20, 21, 22, 23 10
6, 9, 12, 15
Y B
Baress’ Paradox
1 takes route AXB, in 32 minutes.
2 takes route AY B, in 32 minutes.
3 takes route AXY B, in 32 minutes.
4 takes route AXY B, in 32 minutes.
Is this an equilibrium? Are there other equilibria?
6, 9, 12, 15
A X 20, 20.9, 21.8, 22.7
7,
8,
9,
20, 21, 22, 23 10
6, 9, 12, 15
Y B
Baress’ Paradox
What do we learn from this example?
Does it identify any further limitations of the Nash

equilibrium solution concept?
Linear Cournot – set up
Two firms i ∈ {1, 2}.
Simultaneously chooses a quantity to produce qi ≥ 0.
Each unit costs 0 to produce.
Maximize profits: πi = qi P .
Market price depends on total production:

P = 1 − q1 − q2 .
Linear Cournot
With some algebra: πi (qi , qj ) = qi (1 − qi − qj ), for j 6= i.
Firm problem:
max πi (qi , qj ) subject to qi ≥ 0

qi
Guess constraint does not bind, look for a qi that solves:
max qi (1 − qi − qj )
qi
Problem is concave, so first order conditions characterize

a maximum.
FOC implies: (1 − qi − qj ) − qi = 0
Linear Cournot
1−qj
Generates best response functions: Bi (qj ) = 2 .
Slack constraint assumption is good as long as qj < 1.
Suppose qj = 0. Then it is as if i is a monopolist.

In this case: qi = 12 := q M .
πi = q M (1 − q M ) = 12 1 − 12 = 1

4
Linear Cournot
𝑞2
1
𝐵1(𝑞2)
1/2
𝐵2(𝑞1)
1/2 1
𝑞1
Is there a Nash equilibrium? At what quantities?
1−qi
1−qj
qi = 2 and so qi = 1
2 − 2
2 = 1
4 + q4i , so qi = 13 .
Building a Road
Bergstrom, Blume and Varian (86).
Two villages want to build a connecting road.
Road quality improves as more is invested.
Both would benefit from the road.
How will they split the cost of building it in
equilibrium?
Building a Road
Bergstrom, Blume and Varian (86).
Two villages want to build a connecting road.
Road quality improves as more is invested.
Both would benefit from the road.
How will they split the cost of building it in
equilibrium?
. . . in equilibrium both make individually optimal
contributions, given the other’s contribution.
Building a Road-model
Two players i ∈ {1, 2}.

Contributions ai ≥ 0. So Ai is the non-negative
reals.
The quality of the road is q = ai + aj .
ui (ai , aj ) = bi (q) − ai
Building a Road-assumptions
b1 (0) = b2 (0) = 0.
b01 (q) > b02 (q) for all q ≥ 0.
b02 (0) > 1
b00i (q) < 0 for i = 1, 2.
There exists a q̂ > 0 such that b01 (q̂) = 1.
Building a Road-analysis
How can we find best responses?
How can we find best responses?
Player 1’s problem (for a given a2 ):
max b1 (a1 + a2 ) − a1 subject to a1 ≥ 0.

a1
Objective is concave, constraint is linear, so set up

and solve Lagrangian:
max L(a1 ) = b1 (a1 + a2 ) − a1 + λ1 a1

a1
where λ1 ≥ 0 – shadow value of relaxing the

constraint.
Aside: Lagrangians
Example: Suppose
√ √
b1 (q) = 2 q and b2 (q) = q
What does 2’s problem look like?
max L(a2 ) = b2 (a1 + a2 ) − a2 +λ a

a2 | {z } | {z2 }2
Initial Objective Adjustment
with λ ≥ 0.
Aside: Lagrangians
Example: Suppose
√ √
b1 (q) = 2 q and b2 (q) = q
max L(a2 ) = b2 (a1 + a2 ) − a2 +λ a

a2 | {z } | {z2 }2
with λ ≥ 0. Why +λ2 a2 and not −λ2 a2 ?

Aside: Lagrangians
Example: Suppose
√ √
b1 (q) = 2 q and b2 (q) = q
max L(a2 ) = b2 (a1 + a2 ) − a2 +λ a

a2 | {z } | {z2 }2
with λ ≥ 0. Why +λ2 a2 and not −λ2 a2 ?
To penalise the objective:

Maximization problem so reduce objective when
constraint is violated.
Initial Objective
1.2
1.0
0.8
0.6
0.4
0.2
a2
-1.0 -0.5 0.5 1.0
For a1 = 1.
Lagrangians
Can we change the objective so the first order conditions
yield the correct (constrained) maximum?
Need an adjustment to make the interior optimal be at 0.
Need:

dL(a2 )
=0
da2 a2=0
So set:
λ2 = 1 − b02 (a1 )
Adjusted Objective
1.4
Initial Objective
1.2
1.0
0.8
Adjusted Objective 0.6
0.4
0.2
a2
-1.0 -0.5 0.0 0.5 1.0
for a1 = 1.
Lagrangians
Used that the unconstrained optimal violates constraint.
Don’t typically know that.
If constraint doesn’t bind want to leave the objective

unaffected.
This is where complementary slackness comes in.

Adjusted Objective With Complementary
Slackness
1.4
Initial Objective
1.2
1.0
0.8
Adjusted Objective 0.6
0.4
0.2
a2
-1.0 -0.5 0.0 0.5 1.0
Lagrangians–summary
Change the problem to:
max L(a2 ) = b2 (1 + a2 ) − a2 +λ a
a2 | {z } | {z2 }2
Constraint doesn’t bind: We get back the original

objective.
Constraint binds: First order conditions are now at the

boundary.
Here Lagrangian has the same value as the initial
objective (because a2 = 0 and so λ2 a2 = 0).
max L(a1 ) = b1 (a1 + a2 ) − a1 + λ1 a1
a1
Complementary slackness: λ1 > 0 implies a1 = 0

and a1 > 0 implies λ1 = 0.
F.O.C: b01 (a1 + a2 ) − 1 + λ1 = 0.
So either a1 > 0 and b01 (a1 + a2 ) = 1 or a1 = 0 and

b01 (a1 + a2 ) ≤ 1.
By symmetry, either a2 > 0 and b02 (a1 + a2 ) = 1 or

a2 = 0 and b02 (a1 + a2 ) ≤ 1.
Can we have an equilibrium in which both 1 and 2 make

positive contributions?
Can we have an equilibrium in which both 1 and 2 make

No, if there were such an equilibrium (a∗1 , a∗2 ) we’d

need to have b01 (a∗1 + a∗2 ) = b02 (a∗1 + a∗2 ) = 1.
Can we have an equilibrium in which neither make

Can we have an equilibrium in which neither make

No, this implies b01 (0) < 1 and b02 (0) < 1.
Can we have an equilibrium in which 2 makes a positive

contribution and 1 does not?

No, this implies b01 (a∗1 + a∗2 ) < 1 and b02 (a∗1 + a∗2 ) = 1.


Yes, this implies b01 (a∗1 + a∗2 ) = 1 and

b02 (a∗1 + a∗2 ) ≤ 1.
What else might this model apply to?


Yes, this implies b01 (a∗1 + a∗2 ) = 1 and

b02 (a∗1 + a∗2 ) ≤ 1.
What else might this model apply to? Public goods.
e.g., street lighting, defence, parks, etc.

Outline
Introduction
Nash Equilibria
Dominant Actions

Dominant Actions
Critique of Nash equilibrium is that in equilibrium people
need to somehow have correct beliefs.
If beliefs don’t matter, we have a stronger prescription.
ai is dominant for i if it is strictly better for i than any

other action a0i ∈ Ai , regardless of what others do
Definition ((Strictly) Dominant Actions)

An action ai is (strictly) dominant for i if
ui (ai , a−i ) > ui (a0i , a−i ) for all a0i ∈ Ai \ ai and for all
a−i ∈ A−i .
Dominant Actions
Critique of Nash equilibrium is that in equilibrium people
need to somehow have correct beliefs.
If beliefs don’t matter, we have a stronger prescription.
ai is dominant for i if it is strictly better for i than any

other action a0i ∈ Ai , regardless of what others do
Definition ((Strictly) Dominant Actions)

An action ai is (strictly) dominant for i if
ui (ai , a−i ) > ui (a0i , a−i ) for all a0i ∈ Ai \ ai and for all
a−i ∈ A−i .
Have we seen any dominant actions?
Dominated Actions
It is helpful to also consider actions that are dominated.
Definition ((Strictly) Dominated Actions)

An action ai is (strictly) dominated if there exists an
a0i ∈ Ai such that ui (ai , a−i ) < ui (a0i , a−i ) for all
a−i ∈ A−i .
Dominant Actions: Discussion
Experimental evidence on Nash equilibria is mixed.
Relies on rationality and correct beliefs. Tests of Nash

equilibria are joint tests.
When there is a dominant strategy can test the

rationality part alone.
We find there is still some divergence from N.E.
But, it is hard to ensure that people are playing the

game we think they are.
Weakly Dominant Actions
An action ai is weakly dominant for i if it is weakly

better for i than any other action a0i ∈ Ai regardless of
what of the other players do:
Definition (Weakly Dominant Actions)

An action ai is weakly dominant if
ui (ai , a−i ) ≥ ui (a0i , a−i ) for all a0i ∈ Ai and for all
a−i ∈ A−i and there is no a0i such that
ui (ai , a−i ) = ui (a0i , a−i ) for all a−i ∈ A−i .
Weakly Dominated Actions
Definition (Weakly Dominated Actions)

An action ai is weakly dominated if there exists an
a0i ∈ Ai such that ui (ai , a−i ) ≤ ui (a0i , a−i ) for all
a−i ∈ A−i .
Dominated Actions and Nash Equilibria
Can an action that is strictly dominated ever be

played in a Nash equilibrium?

played in a Nash equilibrium? No.

Can an action that is weakly dominated ever be

played in a Nash equilibrium?

Can an action that is weakly dominated ever be

played in a Nash equilibrium? Yes.
Outline
Introduction
Nash Equilibria
Dominant Actions

Asking experts
Suppose you are seeking advice on a contentious issue to
help you choose an action x ∈ [0, 1] .
You want to seek the opinion of experts.
The experts have different opinions and you don’t

want to rely on a single one.
But collectively they have useful information.
You have to decide whether to take their mean

recommendation or median recommendation.
Does it matter which you choose?

Condorcet’s Jury Theorem
More on this later, but loosely, suppose you want to
reach a good decision and individuals have different
information about what the decision should be.
If:
1. Different judgements are stochastically independent,
given the true state.
2. Each individual’s judgement is better than random
Then following the median opinion is good for reaching

the correct judgements.
Eliciting Recommendations
But, Condorcet’s jury theorem only applies if experts
report their true beliefs.
Suppose you ask an odd number (n) of experts for
recommendations ri ∈ R.
And commit to choose the median recommendation:
median(r).
Expert i believes that pi ∈ R is the best policy, and
prefers a recommendations vector r to r0 if and only if:
(median(r) − pi )2 < (median(r0 ) − pi )2

If an expert’s most preferred policy is pi , what

recommendation will she make?
If an expert’s most preferred policy is pi , what

recommendation will she make?
Claim: Weakly dominant for each player to report

truthfully and select ri = pi .
If median of (r−i , pi ) is pi , i doesn’t want to change.
If median of (r−i , pi ) is strictly greater than pi

i cannot decrease median with any other report,
so ri = pi is optimal.
If median of (r−i , pi ) is strictly less than than pi

i cannot increase median with any other report,
If median of (r−i , pi ) is pi , i doesn’t want to change.
If median of (r−i , pi ) is strictly greater than pi

i cannot decrease median with any other report,
If median of (r−i , pi ) is strictly less than than pi

i cannot increase median with any other report,
Is choosing ri = pi a strictly dominant action? No.

Second Price Sealed Bid Auction
N = {1, . . . , n}
There is an object up for auction. Person i’s value of the

object is vi .
Simultaneously choose bid bi ≥ 0.
Object won by highest bid.
But, price paid is that of the second highest bid.
If multiple bids are equal highest, these bidders win with

equal probability.
If i wins the object and pays price p, then ui = vi − p.
If i does not wins the object, then ui = 0.
What price should i bid?
Claim: weakly dominant for i to bid bi = vi .

If i wins the object and pays price p, then ui = vi − p.
If i does not wins the object, then ui = 0.
What price should i bid?
Claim: weakly dominant for i to bid bi = vi . Why?

For any b−i , probability that i wins is increasing in bi .
i wants to win if and only if vi ≥ p, and is indifferent if

vi = p.
If i bids bi = vi , wins if bi = vi ≥ maxj6=i bj = p.
If i bids bi = vi , loses if bi = vi < maxj6=i bj .
In which case, p ≥ vi .
So he wins and loses precisely when he wants to.

Holds regardless of the b−i .
So bidding bi = vi weakly dominates bidding any other

value.
Is this a Nash equilibrium?


value.
Is this a Nash equilibrium? Yes.
Are there other Nash equilibria?


value.
Are there other Nash equilibria? Yes.


value.
Are there other Nash equilibria? Yes.
Suppose (any) person i bids bi > maxk∈N vk and all

others j 6= i, bid bj = 0.
Outline
Introduction
Nash Equilibria
Dominant Actions

Any strategies strictly dominated?
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 9,3 1,6 8,7
Player 1
𝑋 6,0 4,2 1,4 5,3

𝑌 1,9 3,9 0,1 2,9
𝑍 4,0 4,1 2,5 7,8
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 9,3 1,6 8,7
Player 1
𝑋 6,0 4,2 1,4 5,3

𝑌 1,9 3,9 0,1 2,9
𝑍 4,0 4,1 2,5 7,8
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 9,3 1,6 8,7
Player 1
𝑋 6,0 4,2 1,4 5,3

𝑌 1,9 3,9 0,1 2,9
𝑍 4,0 4,1 2,5 7,8
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 9,3 1,6 8,7
Player 1
𝑋 6,0 4,2 1,4 5,3

𝑌 1,9 3,9 0,1 2,9
𝑍 4,0 4,1 2,5 7,8
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 9,3 1,6 8,7
Player 1
𝑋 6,0 4,2 1,4 5,3

𝑌 1,9 3,9 0,1 2,9
𝑍 4,0 4,1 2,5 7,8
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 9,3 1,6 8,7
Player 1
𝑋 6,0 4,2 1,4 5,3

𝑌 1,9 3,9 0,1 2,9
𝑍 4,0 4,1 2,5 7,8
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 9,3 1,6 8,7
Player 1
𝑋 6,0 4,2 1,4 5,3

𝑌 1,9 3,9 0,1 2,9
𝑍 4,0 4,1 2,5 7,8
Iterated Deletion of Strictly Dominated
Strategies
Algorithm for ruling out some action profiles:
(i) Start with a game Γ = (N, {Ai }ni=1 , {ui }ni=1 ). Set
Γ0 = Γ.
(ii) If in Γ0 an action ai is strictly dominated, eliminate
it from consideration—remove it from Ai .
(iii) Let A0i be i’s new action set. Set Γ0 to reflect this
change in i’s action set and return to step (ii).
(iv) If in Γ0 no action action ai is strictly dominated,
terminate the algorithm.
Discussion
When this yields a unique prediction, we say that
the game is dominance solvable.
Does the order of deletion matter?

Discussion

I No. But it would do if we deleted weakly dominated
strategies.
I This is why we only do this with strictly dominated
strategies.
I Can get inconsistent predictions otherwise.
Discussion

I No. But it would do if we deleted weakly dominated
strategies.
I This is why we only do this with strictly dominated
strategies.
I Can get inconsistent predictions otherwise.
Do we rule out actions that are reasonable?

Outline
Introduction
Nash Equilibria
Dominant Actions

Back to Linear Cournot
Simultaneously chooses a quantity to produce qi ≥ 0.
Each unit costs c to produce.
Maximize profits: πi = qi (P − c).
Market price depends on total production:

P = 1 − q1 − q2 .
Back to Linear Cournot
Firm i choose qi ≥ 0 to maximizes πi = qi P − qi c.
Ignoring the non-negativity conditions, FOC:

1 − 2qi − qj − c = 0.
1−qj −c
So, Bi (qj ) = 2 and constraint slack if qj < 1 − c.
1−c
Monopoly output (qj = 0): qi = 2 := q M .
Monopoly profits:
1−c 2−1+c−2c
(1−c)2
πi = q M (1 − q M − c) = 2 2 = 4
Dominance Solvability
Proposition
The linear Cournot game with two identical firms is
dominance solvable. The only actions surviving the
iterated deletion of dominated strategies are
2qm
q1 = q2 = 1−c
3 = 3 .
Proof
For this proof, we’ll need the following Lemma.
Lemma
Suppose qj ∈ [q, q], then all qi > Bi (q) are strictly
dominated by qi = Bi (q) and all qi < Bi (q) are strictly
dominated by Bi (q)
Lemma Proof
1−q−c
Bi (q) = 2 := q̂i .
Consider any qi < q̂i . Define
D(qj ) = πi (q̂i , qj ) − πi (qi , qj )

= q̂i (1 − q̂i − qj − c) − qi (1 − qi − qj − c)
Lemma Proof
1−q−c
Bi (q) = 2 := q̂i .

= q̂i (1 − q̂i − qj − c) − qi (1 − qi − qj − c)
Need to show D(qj ) > 0 for all qi < q̂i and all qj ∈ [q, q].
Can we sign D(q)?
Lemma Proof
1−q−c
Bi (q) = 2 := q̂i .

= q̂i (1 − q̂i − qj − c) − qi (1 − qi − qj − c)
Need to show D(qj ) > 0 for all qi < q̂i and all qj ∈ [q, q].
Can we sign D(q)? Yes!
Because q̂i is the unique best response to qj = q,
D(q) > 0.
Lemma Proof
So q̂i is better than qi < q̂i when j chooses qj = q.
We need this to also hold for all qj ∈ [q, q).

Lemma Proof
So q̂i is better than qi < q̂i when j chooses qj = q.
We need this to also hold for all qj ∈ [q, q).
Note that D0 (qj ) = −q̂i + qi < 0.
So, for all qj < q, D(qj ) > 0.
Thus q̂i dominates any qi < q̂i .
Proof for the second part follows same reasoning.

Applying the Lemma
𝑞𝑖
0 𝑞𝑚
𝑞𝑗
0 𝑞𝑚
Applying the Lemma
𝑞𝑖
0 𝑞𝑚
𝐵𝑖 (𝑞𝑗 = 0)
𝑞𝑗
0 𝑞𝑚
Applying the Lemma
𝑞𝑖
0 𝑞𝑚
𝐵𝑗(𝑞𝑖 = 0)
𝑞𝑗
0 𝑞𝑚
Applying the Lemma
𝑞𝑖
0 𝑞𝑚 𝑞𝑚
2
𝐵𝑖 (𝑞𝑗 = 𝑞𝑚)
𝑞𝑗
0 𝑞𝑚
Applying the Lemma
𝑞𝑖
0 𝑞𝑚 𝑞𝑚
2
𝐵𝑗(𝑞𝑖 = 𝑞𝑚)
𝑞𝑗
0 𝑞𝑚
Applying the Lemma
𝑞𝑖
0 𝑞𝑚 3𝑞𝑚 𝑞𝑚
2 4
𝐵𝑖 (𝑞𝑗 = 𝑞𝑚Τ2)
𝑞𝑗
0 𝑞𝑚
Applying the Lemma
B(0) = qm
Applying the Lemma
B(0) = qm
qm
B(B(0)) = B 2 (0) =
2
Applying the Lemma
B(0) = qm
qm qm
B(B(0)) = B 2 (0) = = qm −
2 2
Applying the Lemma
B(0) = qm
qm qm
B(B(0)) = B 2 (0) = = qm −
2 2
3q m
B 3 (0) =
4
Applying the Lemma
B(0) = qm
qm qm
B(B(0)) = B 2 (0) = = qm −
2 2
3q m qm qm
B 3 (0) = = qm − +
4 2 4
Applying the Lemma
B(0) = qm
qm qm
B(B(0)) = B 2 (0) = = qm −
2 2
3q m qm qm
B 3 (0) = = qm − +
4 2 4
5qm
B 4 (0) =
8
Applying the Lemma
B(0) = qm
qm qm
B(B(0)) = B 2 (0) = = qm −
2 2
3q m qm qm
B 3 (0) = = qm − +
4 2 4
5qm qm qm qm
B 4 (0) = = qm − + −
8 2 4 8
Applying the Lemma
B(0) = qm
qm qm
B(B(0)) = B 2 (0) = = qm −
2 2
3q m qm qm
B 3 (0) = = qm − +
4 2 4
5qm qm qm qm
B 4 (0) = = qm − + −
8 2 4 8
What is B t (0)?
Applying the Lemma
B(0) = qm
qm qm
B(B(0)) = B 2 (0) = = qm −
2 2
3q m qm qm
B 3 (0) = = qm − +
4 2 4
5qm qm qm qm
B 4 (0) = = qm − + −
8 2 4 8
What is B t (0)?
k
B t (0) = qm tk=0 − 12
P
Applying the Lemma
We can find the limit of this sequence
Everything else is eliminated by the iterated deletion of

dominated strategies.
t k
X 1
lim qm − =
t→∞ 2
k=0
Applying the Lemma
We can find the limit of this sequence
Everything else is eliminated by the iterated deletion of

dominated strategies.
t k
X 1 qm 2qm
lim qm − = 1 = .
t→∞ 2 1 + 2
3
k=0
Outline
Introduction
Nash Equilibria
Dominant Actions

Linear Price Competition
Bertrand model
Firms (simultaneously) chooses prices pi ≥ 0.
To maximize profits: πi = qi pi − qi c.
The amount sold depends on the other firm’s price
and a firm’s own price:

 1 − pi
 if pi < pj
1−pi
qi = 2 if pi = pj

0 if pi > pj .
Linear Price Competition
Suppose there was only one firm. What price would i
set?
max(1 − pi )(pi − c) = pi − p2i − c + pi c

pi ≥0
F.O.C: 1 − 2pi + c = 0.
1+c
So pi = 2 := pM
2−1−c
1+c−2c (1−c)2
πi (pi ) = 2 2 = 4
Best Responses
What is the best response of firms i to a price pj ?
Best Responses
What is the best response of firms i to a price pj ?


 Any pi > pj if pj <c

 Any p ≥ c
i if pj =c
Bi (pj ) =

 Does not exist if pj ∈ (c, pM ]

 M
p if pj > pM
Note: pj ∈ (c, pM ] means c < pj ≤ pM .

Nash equilibrium
Proposition
There is a unique Nash equilibrium in which pi = pj = c.
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Proof
𝑝𝑗
𝑐 𝑝𝑖
Discussion: Cournot Vs Bertrand
Does price or quantity competition make a
difference for a monopolist?
With competition there is a big difference: Bertrand

profits are zero. Cournot profits are not.
Why the difference? Strategic substitutes and

strategic complements.
Which model is better?

Discussion: Cournot Vs Bertrand
Does price or quantity competition make a
difference for a monopolist?
With competition there is a big difference: Bertrand

profits are zero. Cournot profits are not.
Why the difference? Strategic substitutes and

strategic complements.
Which model is better? Depends on the situation

being modeled
Political Platforms
Would like a model to help us think about the

political platforms politicians choose.
The space of policies / ideology is quite abstract.
Is there a simple way to capture something

important in these choices?
Political Platforms
Hotelling model is widely known and used:
Assume politicians differ in only one dimension –

how liberal / conservative they are.
I Model this as the unit interval: [0, 1].

Political Platforms
Electorate have different preferences.
Model them as a continuum with mass 1.
Assume preferences of the electorate are single
peaked.
I Each person has a most preferred point in [0, 1],
I and prefers politicians closer to this point.
Ideal preferences described by a density function

f (x).
Rx
t=0 f (t)dt is the proportion of people who’s most
preferred policy lies in the interval [0, x].
Political Platforms
Suppose there are two politicians, i = 1, 2.
Each politician must commit to a platform

xi ∈ [0, 1] and then implement consistent policies if
elected.
All members of electorate vote for the platform they

prefer. If indifferent, toss a coin.
Politicians prefer winning the election, to tieing to

losing.
What are the Nash equilibria?

Proposition
Proposition
There is a unique Nash equilibrium of the two player
Hotelling model. Letting M be the solution to
Z M
1
f (t)dt = ,
t=0 2
both candidates locate at M and the election is a tie.
Proof Outline
Locating at M guarantees don’t lose.
So, there is no Nash equilibrium with a winner.

I Loosing politician would have a profitable deviation.
For a tie at X 6= M , relocating to M is a profitable

deviation.
Only remaining possibility: Both locate M .
Both doing so are mutual best responses.

Discussion
Does this model capture anything “real.”
In some instances (historically), elections seem to

have been won from the center ground.
Perhaps New Labour and Tony Blair.
But in recent times, many politicians seem to be

locating further from the center ground.
Is something missing from the model?

Product Differentiation
Can we apply this model to think about product
differentiation in the Bertrand model?
Suppose two firms 1, 2 have fixed locations at 0 and

1 respectively.
Simultaneously choose prices p1 , p2 .
A consumer at location l ∈ [0, 1] who buys from

firm i located at xi gets:
v − (l − xi )2 t − pi .
where t captures the size of transportation costs.

Let a unit mass of consumers be located uniformly
on the unit interval.
So, mass of consumers to left of location l is l.
Suppose prices p1 and p2 are charged.
If −t ≤ p1 − p2 ≤ t and v is sufficiently high, there’s

an indifferent consumer at l∗ :
v − (l∗ )2 t − p1 = v − (1 − l∗ )2 t − p2 ,
t+p2 −p1
and so l∗ = 2t
Demands
0 𝑙∗ 1
Demands
1𝑙 ∗ 1(1 − 𝑙 ∗ )
0 𝑙∗ 1
Consumers closer to firm i than l∗ then buy from i and

so demand is:
q1 (p1 , p2 ) = t+p2t2 −p1
q2 (p1 , p2 ) = t−p2t2 +p1
Thus firm i = 1, 2 solves the problem:
max qi (pi , pj )(pi − c).

pi ≥0
From the first order conditions:
t + p2 + c
p1 =
2
t + p1 + c
p2 =
2
Solving these best response functions, in equilibrium

p1 = p2 = t + c.
Guesses were correct: prices not too different and

non-negative.
What do we learn from this?

Hotelling with 3 players
Now there are three politicians, i = 1, 2, 3.

Each politician decides whether to enter, and if so
commits to a platform xi ∈ [0, 1].
All members of the electorate vote for the platform
closest to their ideal point.
Politicians prefer winning the election to tieing to
not participating to losing.
Otherwise, as before.
Hotelling with 3 players
Proposition
There is no Nash equilibrium of the three player
Hotelling model with entry.
Proof Outline
If none enter, then there is a profitable deviation
from one entering.
If one enters, then there is a profitable deviation
from another entering
I Can enter at M and at worst tie the election.
If two enter, then (by previous argument) both

locate at M .
Other politician could then enter and win by

locating just left or right of M .
If all three enter and at least one looses, that

politician would prefer not to enter.
Outline

Notation and Concepts
Mixed strategies: Applications
Mixed Strategies: Existence of a Nash Equilibrium
Mixed Strategies: Dominance
Limitations in practice
Mixed Strategies: mass-action / population interpretation
Mixed Strategies: Stability

Rock, Paper, Scissors
Player 2
Rock Paper Scissors
Rock 0, 0 −1, 1 1, −1
Player 1 Paper 1, −1 0, 0 −1, 1
Scissors −1, 1 1, −1 0, 0
Is there a Nash equilibrium?
Rock, Paper, Scissors
Player 2
Rock Paper Scissors
Rock 0, 0 −1, 1 1, −1
Player 1 Paper 1, −1 0, 0 −1, 1
Scissors −1, 1 1, −1 0, 0
Is there a Nash equilibrium? No.
How do you expect people to play?

Randomization
Want to introduce randomization.

Randomization
Want to introduce randomization.
Key questions:
(i) How can we model preferences over lotteries?
(ii) What are players’ actions sets?

Preferences over lotteries
Will use von-Neumann Morgenstern utility functions.
Preferences over lotteries
Will use von-Neumann Morgenstern utility functions.
Weight each outcome by the probability it occurs.
Let:
I Let α(a) be the probability of an action profile a ∈ A
I u(a) be the utility of that outcome for sure.
Then the v-NM utility function is:
X
U (α) = α(a)u(a)
a∈A
Example
Suppose there are two possible action profiles a and
a0 .
ui (a) is i’s utility from a, and ui (a0 ) from a0 .
Want to represent preferences over lotteries.
Suppose i strictly prefers the lottery (α(a), α(a0 )) to

(β(a), β(a0 )).
Then, if i has v-NM preferences:
α(a)ui (a) + α(a0 )ui (a0 ) > β(a)ui (a) + β(a0 )ui (a0 ).
Discussion
Are utilities still ordinal?

Discussion
Does the formulation mean that people don’t care

about taking risks?
Discussion
Does the formulation mean that people don’t care

about taking risks?
Example:
I 50% chance of 0 dollars, 50% chance of 1000 dollars.
I Prefer 500 dollars, but indifferent to 450 for sure.
I u(0) = 0; u(1000) = 10; u(450) = 5; u(500) > 5.
Action sets
Suppose there are m actions in Ai .
Now choose probability distribution

αi : Ai → [0, 1]m over these actions.
i.e., probabilities αi (ai ) ∈ [0, 1] of playing each

action ai ∈ Ai .
Action sets


action ai ∈ Ai .
Represent set of probability distribution over Ai by

( )
X
∆(Ai ) := αi : αi (ai ) ∈ [0, 1] and αi (ai ) = 1 .
ai ∈Ai
Action sets


action ai ∈ Ai .
Represent set of probability distribution over Ai by

( )
X
∆(Ai ) := αi : αi (ai ) ∈ [0, 1] and αi (ai ) = 1 .
ai ∈Ai
Thus i chooses a mixed strategy αi ∈ ∆(Ai ).

Nash Equilibria
What is a Nash Equilibrium now?

Nash Equilibria
A mixed strategy profile α is a (mixed strategy) N.E. if

and only if
Ui (αi , α−i ) ≥ Ui (α̂i , α−i ) for all α̂i ∈ ∆(Ai ) and for all i.
Nash Equilibria
A mixed strategy profile α is a (mixed strategy) N.E. if

and only if
Ui (αi , α−i ) ≥ Ui (α̂i , α−i ) for all α̂i ∈ ∆(Ai ) and for all i.
Is there a mixed strategy Nash equilibrium for

Rock-Paper-Scissors?
Is it unique?
Indifference
In Rock-Paper-Scissors i’s mixed strategy makes j

indifferent about the alternatives.
Indifference

General property of MSNE:

Must be indifferent about everything you mix over
with positive probability.
Indifference

General property of MSNE:

Must be indifferent about everything you mix over
with positive probability.
Very useful when trying to find MSNE.

A twist...
Player 2
Rock Paper Scissors
Rock 0, 0 −1, 1 2, −1
Player 1 Paper 1, −1 0, 0 −1, 1
Scissors −1, 2 1, −1 0, 0
What is different about this game?
A twist...
Player 2
Rock Paper Scissors
Rock 0, 0 −1, 1 2, −1
Player 1 Paper 1, −1 0, 0 −1, 1
Scissors −1, 2 1, −1 0, 0
What is different about this game?
What is the new MSNE?
A twist...
Suppose player i = 1, 2 plays:
rock with probability ri > 0
paper with probability pi > 0
scissors with probability si > 0,
We then have:
U1 (rock) = 0r2 − 1p2 + 2s2
U1 (paper) = 1r2 + 0p2 − s2
U1 (scissors) = −1r2 + 1p2 + 0s2
By the indifference property:
U1 (rock) = U1 (paper) = U1 (scissors).
A twist...
Using these indifference conditions, we can solve for a

new mixed strategy Nash equilibrium.
In this equilibrium:
1 5 1
ri = pi = si = .
3 12 4
Are there any other mixed strategy Nash equilibria in
which both i and j mix over all alternatives?
Conceptual Issues with Mixed Strategies
How realistic is randomization? Do people really
randomize?
Choices only need to appear random.
For example, taking a penalty in football.
Randomize depending on whether date is odd or

even.
Not random, but probably appears random.

Conceptual Issues with Mixed Strategies
How realistic is randomization? Do people really
randomize?
Choices only need to appear random.
For example, taking a penalty in football.
Randomize depending on whether date is odd or

even.
Not random, but probably appears random.
More fundamentally: People must randomize even

though they can do just as well playing a pure
strategy.
Outline


Tennis Serving
A simple model of serving in tennis.

The server choose an action from
As = {down line, across court}
The returner chooses an action from

Ar = {down line, across court}
Players want to maximize probability they win the

point.
Tennis Serving
An example of possible point winning probabilities:
Returner
Down Across
line Court
Down
Server
0.5, 0.5 0.8, 0.2

Line
Across 0.7, 0.3 0.4, 0.6
Court
Tennis Serving
ds is probability serves chooses down line.
dr is probability the returner chooses down line.
Probability of across court is 1 minus probability

down line.
There is no pure strategy Nash equilibrium.
Look for a mixed strategy Nash equilibrium.

Tennis Serving
Server’s expect payoff from choosing down line is:
0.5dr + 0.8(1 − dr ).
Server’s expect payoff from choosing across court is:
0.7dr + 0.4(1 − dr ).
Serves chooses ds ∈ [0, 1] to maximize expected payoff
ds [0.5dr + 0.8(1 − dr )] +(1 − ds ) [0.7dr + 0.4(1 − dr )] .

| {z } | {z }
Expected payoff from DL Expected payoff from AC
Tennis Serving
This is maximized by ds = 1 if
[0.5dr + 0.8(1 − dr )] > [0.7dr + 0.4(1 − dr )].
And maximized by ds = 0 if
[0.5dr + 0.8(1 − dr )] < [0.7dr + 0.4(1 − dr )].

Tennis Serving
Thus, in equilibrium, the server mixes only if:
[0.5dr + 0.8(1 − dr )] = [0.7dr + 0.4(1 − dr )].
This is the indifference condition. It holds if and only if
dr = 2/3.
And in this case, any ds ∈ [0, 1] is optimal for the server.

Tennis Serving
Similarly, the returner mixes only if:
[0.5ds + 0.3(1 − ds )] = [0.2ds + 0.6(1 − ds )],
which requires ds = 1/2.
In this case any dr ∈ [0, 1] is optimal.
Thus, there is a (unique) mixed strategy Nash

equilibrium in which
ds = 1/2 and dr = 2/3.

Best Response Correspondences
1 𝐵𝑠(𝑑𝑟)
𝑑𝑠
0
0 𝑑𝑟 2/3 1
𝑑𝑠
𝐵𝑟(𝑑𝑠)
0
0 𝑑𝑟 2/3 1
1 𝐵𝑠(𝑑𝑟)
𝑑𝑠
𝐵𝑟(𝑑𝑠)
0
0 𝑑𝑟 2/3 1
Tennis Serving
Is there a pure strategy NE?
Walker and Wooders (2001) study ten grand slam

finals.
Coded serves left, right. Coded who won point.
What do you think they look for?
Similar results for penalty kicks (Chiappori,

Groseclose and Levitt, 2002)
Bertrand Competition with Sunk Costs
Two risk neutral firms, i = 1, 2.
Produce a homogeneous good.
Single consumer who buys one unit or nothing.
It costs c > 0 to produce one unit.

The consumer has a reservation value v > c.
Buys lowest price good if this is less than or equal

to v.
Tosses a coin if both prices are the same and less

than v.
Firms simultaneously choose:

I whether to announce a price pi ≥ 0
I and, if so, what price to announce.
If a firm quotes a price, it incurs a sunk cost

k ∈ (0, v − c)
I e.g., to pay a salesperson to visit the buyer.
If a firm does not announce a price, it does not pay

k.
If the consumer wishes to buy from a firm, it

produces the good at cost c.
Is there a pure strategy Nash equilibrium?
Is there a pure strategy Nash equilibrium?
Lets look for a symmetric mixed strategy equilibrium
in which:
I both firms enter with probability π ∈ (0, 1).
I conditional on entering naming a price drawn at random
from a continuous CDF F .
I F puts no weight on prices below c + k (F (c + k) = 0)
or higher than v (F (v) = 1) and is strictly increasing
between c + k and v.
Why no prices below c + k or higher than v?

Assuming that the support of F is [c + k, v], how

can we find F and π as functions of p, k, and c?
What do we know about expected payoffs?
If j and i enter, and i chooses a price pi , what is

the probability this is below j’s price?
i’s expected payoff from entering and choosing price pi :
Ui (pi ) = (pi − c)[(1 − πj ) + πj (1 − Fj (pi ))] − k.
As there is a positive probability that i doesn’t enter:
(pi − c) ((1 − πj ) + πj (1 − Fj (pi ))) − k = 0.
Rearranging:

1 pi − c − k
Fj (pi ) =
πj pi − c

1 pi − c − k
Fj (pi ) =
πj pi − c
Support is [c + k, v]. So Fj (c + k) = 0 (holds).
Moreover, Fj (v) = 1.
(v−c−k)
Thus πj = v−c and

0
 if p < c + k
(v−c)(p−c−k)
Fj (p) = (v−c−k)(p−c) if p ∈ [c + k, v] ,

1 if p > v

for j = 1, 2.
Equilibrium CDF
0
𝑐+𝑘 𝑣
𝑝
How do we know this is an equilibrium?
Suppose player 2:
enters with probability π2 = (v−c−k)
v−c
and, conditional on entering, chooses a price
according to the CDF

0
 if p < c + k
(v−c)(p−c−k)
F2 (p) = (v−c−k)(p−c) if p ∈ [c + k, v] ,

1 if p > v

By construction player 1 is then indifferent between

staying out of the market,
entering and choosing any price p1 ∈ [c + k, v].
Intuitively, when choosing a price, 1 faces a trade off:
higher price reduces probability of a sale,
but increase profits conditional on selling.
And when deciding to enter, 1 also faces a trade off:
entry risks not trading and making a loss −k,
but yields profits p1 − c − k when trading.
Player 2’s strategy exactly balances these forces.
Making 1 indifferent between these alternatives.

What alternative actions are left to player 1?

Enter and price below c + k.
Or enter and price above v.
Both these actions yield a negative expected payoff for 1.
And the other actions all yield an expected payoff of 0.

One best response for 1 is therefore to:
enter with probability π1 = (v−c−k)
v−c
and, conditional on entering, chooses a price
according to the CDF

0
 if p < c + k
(v−c)(p−c−k)
F1 (p) = (v−c−k)(p−c) if p ∈ [c + k, v] ,

1 if p > v

But if 1 does this, then 2 is also playing a best response.

Thus we have a Nash equilibrium.
Kitty Genovese
For more than half an hour 38 respectable, law-
abiding citizens in Queens watched a killer stalk
and stab a woman in three separate attacks in
Kew Gardens.
Twice the sound of their voices and the sud-
den glow of their bedroom lights interrupted him
and frightened him off. Each time he returned,
sought her out and stabbed her again. Not one
person telephoned the police during the assault;
one witness called after the woman was dead.
New York Times, March 27, 1964.
Kitty Genovese
Sociological explanations:
People who live in cities don’t care about each
other.
People worry that if they call the police the

perpetrators of the crime might find out who they
are and there may be some kind of reprisal.
But there is a simpler explanation—doesn’t require

calling to be very costly or have few benefits.
Kitty Genovese
Suppose calling the police is a little costly (c > 0).
I Takes time, might mean you have to give a witness
statement later, etc.
Suppose people don’t like the attack, value of

stopping it is v > c.
Police require one call, so attack stopped if anyone

calls:
ui = v1(someone calls) − c1(i calls).

Kitty Genovese
Are there any PSNE?
We’ll look for a symmetric mixed strategy NE.
Suppose all people call with probability p.
To mix, person i must be indifferent. So
v − c = v 1 − (1 − p)n−1 .

This implies that

1
c n−1
p=1− .
v
Kitty Genovese
What is the probability that no one calls?

n
c n−1
n
q = (1 − p) =
v
c
As v < 1, the right hand side is increasing in n.
Probability that no one calls actually increases as

more people watch!!
Kitty Genovese
Suppose, for example that v = 10c.
𝑛
Kitty Genovese
Intuition: Two effects going in opposite directions.

More people to make the call.
But more temptation to free-ride on others.
In equilibrium this second effect dominates.

Outline


Intuition for existence
Under some conditions we have existence of a Nash

equilibrium.
Consider a two player game with A1 = A2 = [0, 1].
Suppose best response functions are continuous.
Then there exists a Nash equilibrium.

1
𝑎2
00 𝑎1 1
1
𝑎2
00 𝑎1 1
1
𝐵1(𝑎2)
𝑎2
00 𝑎1 1
1
𝑎2
00 𝑎1 1
1
𝑎2 𝐵2(𝑎1)
00 𝑎1 1
1
𝐵1(𝑎2)
𝑎2 𝐵2(𝑎1)
00 𝑎1 1
Existence
Result also applies to mixed strategies when

A1 = {a, b} and A2 = {c, d}. Why?
Brouwer’s fixed point theorem
Theorem (Brouwer’s fixed point theorem)

Let X ⊂ Rm be a compact (closed and bounded) and
convex set. Let f : X → X be a continuous function.
Then there is a x∗ ∈ X such that x∗ = f (x∗ ).
Brouwer’s fixed point theorem
Theorem (Brouwer’s fixed point theorem)

Let X ⊂ Rm be a compact (closed and bounded) and
convex set. Let f : X → X be a continuous function.
Then there is a x∗ ∈ X such that x∗ = f (x∗ ).
Suppose we take a coffee cup, swirl the coffee around

and let it come to rest. Is there some point in the liquid
at which the coffee is exactly where it was relative to the
mug before we swirled it?
Brouwer’s fixed point theorem: Conditions
What can go wrong when we don’t have a compact,
convex domain or a continuous function?
1
𝐵2(𝑎1)
𝑎2
𝐵1(𝑎2)
00 𝑎1 1
1
𝐵2(𝑎1) 𝐵1(𝑎2)
𝑎2
00 𝑎1 1
1
𝐵1(𝑎2)
𝐵2(𝑎1)
𝑎2
00 𝑎1 1
Applying Brouwer
How can we represent Nash equilibria as fixed
points?
Consider a game with two people.
In a Nash equilibrium (a∗1 , a∗2 ), B1 (a∗2 ) = a∗1 and

B2 (a∗1 ) = a∗2 .
Define B(a) = (B1 (a2 ), B2 (a1 )).
Then, B(a∗ ) = a∗ .
Existence: Mixed Strategies
For any finite set Ai , ∆(Ai ) is a closed, bounded

and convex set.
Utilities on ∆(Ai ) are continuous.
Can show best responses are then continuous too.
Thus there exists a mixed strategy Nash equilibrium.

Existence: Mixed Strategies
Best responses are often not functions but
correspondences.
However, there is a similar fixed point theorem that

can be used to establish existence in these cases
(Kakutani’s fixed point theorem)
Existence of mixed strategy NE is the main result in

Nash’s PhD thesis.
Results are harder to establish when Ai is infinite.
Can sometimes use Brouwer to show existence of a

pure strategy Nash equilibrium.
Outline


Finding equilibria
Suppose you are player 1, would you ever play middle
(m)?
Player 2
𝑙 𝑟
8,3 0,3
Player 1
𝑢
𝑚 3,9 3,1
𝑑 0,8 8,9
Finding equilibria
(m)?
Player 2
𝑝 1−𝑝
𝑙 𝑟
8,3 0,3
Player 1
𝑢
𝑚 3,9 3,1
𝑑 0,8 8,9
Finding equilibria
(m)?
8 8
𝜋1(𝑑) 𝜋1(𝑢)
𝜋1(𝑚)
0 0
0 𝑝 1
Finding equilibria
(m)?
8 8
𝜋1(𝑑/2, 𝑢/2)
𝜋1(𝑚)
0 0
0 𝑝 1
Useful Results
Proposition
Action ai is strictly dominated by a mixture of some
other actions if and only if ai is never a best response to
any mixed strategy profile played by the other players.
Proposition
No strictly dominated pure strategy is ever played with
positive probability in a mixed strategy Nash equilibrium.
Finding equilibria
Find all Nash equilibria—mixed and pure.
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 1,3 1,6 8,7
Player 1
𝑋 6,0 7,3 0,3 5,4

𝑌 1,9 5,9 1,1 2,9
𝑍 4,0 4,8 3,9 7,8
Finding equilibria
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 1,3 1,6 8,7
Player 1
𝑋 6,0 7,3 0,3 5,4

𝑌 1,9 5,9 1,1 2,9
𝑍 4,0 4,8 3,9 7,8
Finding equilibria
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 1,3 1,6 8,7
Player 1
𝑋 6,0 7,3 0,3 5,4

𝑌 1,9 5,9 1,1 2,9
𝑍 4,0 4,8 3,9 7,8
Finding equilibria
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 1,3 1,6 8,7
Player 1
𝑋 6,0 7,3 0,3 5,4

𝑌 1,9 5,9 1,1 2,9
𝑍 4,0 4,8 3,9 7,8
Finding equilibria
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 1,3 1,6 8,7
Player 1
𝑋 6,0 7,3 0,3 5,4

𝑌 1,9 5,9 1,1 2,9
𝑍 4,0 4,8 3,9 7,8
Finding equilibria
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 1,3 1,6 8,7
Player 1
𝑋 6,0 7,3 0,3 5,4

𝑌 1,9 5,9 1,1 2,9
𝑍 4,0 4,8 3,9 7,8
Finding equilibria
Player 2
𝐴 𝐵 𝐶 𝐷
𝑊 4,1 1,3 1,6 8,7
Player 1
𝑋 6,0 7,3 0,3 5,4

𝑌 1,9 5,9 1,1 2,9
𝑍 4,0 4,8 3,9 7,8
Finding equilibria
Player 2
𝑝 1−𝑝
𝐶 𝐷
Player 1
𝑞 𝑊 1,6 8,7
1 − 𝑞 𝑍 3,9 7,8
1’s indifference: 𝑝1 + 1 − 𝑝 8 = 3𝑝 + 1 − 𝑝 7
2’s indifference: 𝑞6 + 1 − 𝑞 9 = 7𝑞 + 1 − 𝑞 8
Finding equilibria
Player 2
𝑝 1−𝑝
𝐶 𝐷
Player 1
𝑞 𝑊 1,6 8,7
1 − 𝑞 𝑍 3,9 7,8
1’s indifference: 𝑝 = 1/3
2’s indifference: 𝑞 = 1/2
Outline


Is mixing always as predicted?
Sometimes (football, tennis), but perhaps not
always.
Even in tennis, maybe on match point players mix

less well?
Maybe in world-cup shoot out more likely to shoot

to a favored side?
Hard to test—less data.
Don’t these players try to anticipate what the other

will do?
Rock-Paper-Scissors
1 1 1

Do you really try to choose according to 3, 3, 3 ?
Suppose you think other person is:

1 1 1

randomizing 3
, 3
, 3
with probability 1 − ε.
1 1 1

randomizing 2
, 4
, 4
with probability ε.
If ε > 0, is it still optimal for you to randomize

1 1 1
3, 3, 3 ?
What if you think, the other player thinks, you

randomize as above?
An Algorithmic Competition
Suppose we were to set up a Rock-Paper-Scissors
tournament.
People get to write algorithms and each algorithm

plays each other 1000 times.
There are also some simple algorithms that the

organizers enter.
What would your algorithm look like? Is

randomization your best bet?
This was a real programming contest (RoShamBo).

An Algorithmic Competition
The first one was run in the late 1990s. It attracted
some top competitors.
People who wrote programs to gamble online.
Winners of other programming competitions

(Loebner prize).
Jonathan Shaeffer who wrote the first computer

program to win an official world championship
against humans (at drafts).
What strategy would you program?

Iocaine Powder
Won by a program called Iocaine Powder after a

scene in the Princess Bride.
And won very convincingly.
25 independent tournaments, the results of which

were then aggregated
Iocaine Powder won all 25 tournaments.

Quote from Nash’s Dissertation
We shall now take up the ‘mass-action’ inter-

pretation of equilibrium points. In this interpre-
tation solutions have no great significance. It
is unnecessary to assume that the participants
have full knowledge of the total structure of the
game, or the ability and inclination to go through
any complex reasoning process. But the partic-
ipants are supposed to accumulate empirical in-
formation on the relative advantages of the var-
ious pure strategies at their disposal.
To be more detailed, we assume that there is

a population (in the sense of statistics) of par-
ticipants for each position of the game. Let us
assume that the ‘average playing’ of the game
involves n participants selected at random from
the n populations, and that there is a stable av-
erage frequency with which each pure strategy
is employed by the ‘average member’ of the ap-
propriate population.
Since there is to be no collaboration between

individuals playing in different positions of the
game, the probability that a particular n-tuple
of pure strategies will be employed in a playing
of the game should be the product of the prob-
abilities indicating the chance of each of the n
pure strategies to be employed in a random play-
ing.
Lizards
(Scheriber and Killingback, 2012)
Uta stansburiana, the common side-blotched lizard,
comes in a variety of colors.
Indicative different hormone and mating strategies.
Blue-throated males devoted to mates. Small

territories.
Orange-throated males are the largest, with the

most testosterone. Large territories.
Orange throats can drive blue-throats out of their

territories.
Lizards
Yellow-throated males have lowest testosterone
levels, and mimic females.
They sneak into orange-throat territory and mate

with females.
But doesn’t work on blue-throats.
Population densities adjust to maintain balance.

Lizards
Yellow-throated males have lowest testosterone
levels, and mimic females.
They sneak into orange-throat territory and mate

with females.
But doesn’t work on blue-throats.
Population densities adjust to maintain balance.
Different interpretation of mixed strategy Nash

equilibria.
People play different pure strategies, but meeting

someone at random it is as if they are mixing.
Outline


iPhone or Android
Player 2
iPhone Android
iPhone 5, 5 4, 2
Player 1
Android 2, 4 6, 6
iPhone or Android
Suppose two mixes as shown:
Player 2
iPhone (p) Android (1 − p)
iPhone 5, 5 4, 2
Player 1
Android 2, 4 6, 6
U1 (iPhone) = 5p + 4(1 − p)
U1 (Android) = 2p + 6(1 − p)
1’s Payoff
We plot 1’s payoff from alternative pure strategies as a
function of 2’s mixing probability p.
6 𝑈1(𝑖𝑃ℎ𝑜𝑛𝑒)
5
4
𝑈1(𝐴𝑛𝑑𝑟𝑜𝑖𝑑) 2
0
0 0.4 𝑝 1
Stability
The mixed strategy Nash equilibrium is unstable.

If the proportion of the population choosing iPhone
increases just slightly.
Everyone would prefer iPhone for sure.
We’d move to this pure strategy equilibrium.
Same for Android.
Risk Dominance
Pair (iPhone, iPhone) is the risk-dominant
equilibrium.
Suppose we are at that equilibrium.
What proportion of the population must switch for
people to prefer Android?
Risk Dominance
Pair (iPhone, iPhone) is the risk-dominant
equilibrium.
Suppose we are at that equilibrium.
What proportion of the population must switch for
people to prefer Android? 60%
But only 40% need to switch if we play (Android,
Android).
Evolutionary arguments suggest risk dominant
equilibria likely to be played over payoff dominant
equilibria.
Hawk Dove Game
Player 2
Hawk Dove
Hawk −1, −1 4, 0
Player 1
Dove 0, 4 2, 2
Hawk Dove Game
Player 2
Hawk Dove
Hawk −1, −1 4, 0
Player 1
Dove 0, 4 2, 2
Two pure strategy Nash equilibria: (Hawk, Dove)

and (Dove, Hawk).
Hawk Dove
Suppose two mixes as shown:
Player 2
Hawk (p) Dove (1 − p)
Hawk −1, −1 4, 0
Player 1
Dove 0, 4 2, 2
U1 (Hawk) = −p + 4(1 − p)
U1 (Dove) = 0 + 2(1 − p)
1’s Payoff
1’s payoff is shown for alternative pure strategies as a function of 2’s
mixing probability p. If there is a single population we are drawing
players from, 2/3rds playing Hawk is stable.
4
𝑈1(𝐻𝑎𝑤𝑘)
2
𝑈1(𝐷𝑜𝑣𝑒)
0
−1
0 2/3 𝑝 1
Outline

Game Trees
Subgame Perfection
Applications: SPNE
Imperfect information
Repeated Games

Entry Game
So far decisions have been simultaneous, but often they
are made sequentially. For example:
Suppose there is a market with an incumbent
monopolist.
First an entrant decides whether to enter or not.
Then the incumbent decides whether to
accommodate or fight entry.
Letting entrant be player 1 and the incumbent
player 2, payoffs are:
I (0, 3) if entrant stays out,
I (−1, 0) if entrant enters and incumbent fights,
I (1, 1) if entrant enters and incumbent accommodates.
Entry Game: Extensive Form
Can represent this information in a game tree:
Incumbent
(1,1)
Acc
In Fight (-1,0)
Entrant Out
(0,3)
More formally
A game tree is a graph (nodes and edges) in which:
There is a finite set of nodes.
Each node is terminal or an action node.
Action nodes are associated with a player and

represent that this players chooses an action.
Branches (edges) from this node represent available

actions.
After each action, there is another node.

More formally
Terminal nodes assign payoffs.
There are no cycles—each node is associated with a

unique history.
A history is sequence of actions that resulted in the

game reaching that node.
Pure Strategies
A strategy si for player i is a complete and
contingent plan.
For i it is a mapping from each node at which i
might move to an action for i to take.
So far, actions have been strategies.
No longer: Strategies are now a vector of actions for
every possible eventuality.
The strategy set of i, denoted Si , is the set of
strategies available to i.
Pure Strategies
What are the strategy sets of the two players?
2 h (1,1)
In
l (-1,0)
1 h (0,3)
Out
2 l (0,0)
Norm Form Representation
Can represent dynamic games in normal form as

well as extensive form.
Just let players simultaneously choose strategies

instead of actions.
Can then apply our definition of Nash equilibrium

directly.
Norm Form Representation
Representing the previous game in normal form
Player 2
ℎ, ℎ ℎ, 𝑙 𝑙, ℎ 𝑙, 𝑙
Player 1
In 1,1 1,1 -1,0 -1,0

Out 0,3 0,0 0,3 0,0
Mixed and Behavioral Strategies
A mixed strategy mixes over the strategies available

to a player.
Exactly as before, but strategies are no longer just

actions.
A behavioral strategy mixes over actions at each

specific node.
Mixed and Behavioral Strategies
As long as players remember the moves they made

(which we’ll always assume—known as perfect recall):
Every behavioral strategy has a mixed strategy

counterpart.
Every mixed strategy has a behavioral strategy

counterpart.
The set of Nash equilibria is the same regardless of

which concept we use.
Outline

Game Trees
Subgame Perfection
Applications: SPNE
Repeated Games

Entry Game
What are the pure strategy Nash equilibria of this game?
Incumbent
(1,1)
Acc
In Fight (-1,0)
Entrant Out
(0,3)
Entry Game
Incumbent
(1,1)
Acc
In Fight (-1,0)
Entrant Out
(0,3)
Entry Game
Incumbent
(1,1)
Acc
In Fight (-1,0)
Entrant Out
(0,3)
Threats and Credibility
Does the (out, fight) equilibrium seem strange?
If the entrant actually entered, what would the

incumbent do?
Threats and Credibility
Does the (out, fight) equilibrium seem strange?
If the entrant actually entered, what would the

incumbent do?
Anticipating this, shouldn’t the entrant enter?
Although the incumbent is deciding a complete and

contingent plan ahead of time, he cannot commit to
this plan.
Fighting, involves a non-credible threat.
How can we rule these out?

Selten, 65
A subgame is defined by:
I taking an action node,
I making this the first node in a new game,
I considering only nodes that can be reached from this
node.
A subgame perfect equilibrium is a strategy profile

that induces Nash equilibria to be played in all
subgames.
All subgames includes those that will not be reached

when the game is played.
This is the crucial difference with Nash equilibrium.

Selten, 65
We call the subgames reached with strictly positive
probability “on-path.”
Nash equilibrium (NE) only requires a NE of the
whole game.
However, this implies NE are played in all on-path
subgames.
Subgame perfection also requires mutual best
responses to be played “off-path”.
Refines the set of equilibria (is a subset of the NE)
Entry Game
What are the subgames? Which Nash equilibria are
subgame perfect?
Incumbent
(1,1)
Acc
In Fight (-1,0)
Entrant Out
(0,3)
Entry Game
subgame perfect?
Incumbent
(1,1)
Acc
Fight (-1,0)
Entry Game
subgame perfect?
Incumbent
(1,1)
Acc
Fight (-1,0)
Entry Game
subgame perfect?
Incumbent
(1,1)
Acc
In Fight (-1,0)
Entrant Out
(0,3)
Centipede Game
You Me You Me You Me

You
pass pass pass pass pass pass pass
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
We’ll come back to this soon. . .

Existence
Are we guaranteed the existence of a subgame
perfect Nash equilibrium (SPNE)?
Existence
Are we guaranteed the existence of a subgame
perfect Nash equilibrium (SPNE)? Yes.
Define length of a subgame as longest possible path
to a terminal node from current node.
Theorem (Zermelo’s Theorem)
In all finite games (finite players, finite length subgames,
finite action sets for each player at each node) of perfect
information (each player knows the history of the game
when making every possible decision), there exists a
subgame perfect equilibrium.
Proof Outline
Proof is by induction.
Let T be the length of the longest subgame.
Consider first subgames of length 1.
Involve a single decision that results in a payoff.
So there is a best response.
For each subgame of length 1 select one such

response.
Proof Outline
Supposing there exists a SPNE for all games of
length t − 1.
Will show there exists a SPNE for all games of

length t.
Then, as we know there is a SPNE for games of

length 1.
There is a SPNE for all games of length 2.
But then there is a SPNE for all games of length 3.

And so on.
Proof Outline
Consider a game of length t
Supposing there exists a SPNE for all games of

length t − 1.
Let play after first move correspond to a SPNE.
Any first move then results in a single terminal node

being reached for certain.
Player making first decision in game of length t

knows payoff from each available action.
Proof Outline
As options are finite, has a best response.
Taking this action now, then all playing according to

the SPNE is a SPNE.
First mover is playing a best response, so it is a NE

for the length t subgame.
By construction, NE are played in all subgames.
So we have a SPNE for the game of length t.
And so by induction there always exists a SPNE.

Intuition
Intuition
Intuition
Intuition
Intuition
Intuition
Intuition
Intuition
What else does this proof suggest?
When do we have a unique SPNE?

What else does this proof suggest?
How might we find SPNE?

Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Centipede Game

You
(5,5)
stop
stop
stop
stop
stop
stop
stop
(3,0) (2,2) (4,1) (3,3) (5,2) (4,4) (6,3)
Back to our questions

Back to our questions
How might we find SPNE?

Centipede Game: Aside
Suppose I am rational, forward looking and

understand the centipede game?
Centipede Game: Aside
Suppose I am rational, forward looking and

understand the centipede game?
Why might I choose to pass the first time I move?

Implication of Zermelo’s Theorem
What does it imply for chess?

Outline

Game Trees
Subgame Perfection
Applications: SPNE
Repeated Games

Sun-Tzu
There are two states.
The first state controls a number of islands off the

coast of the main land.
Other state controls the mainland.
Suppose army from mainland takes one of the small

islands connected to mainland by a bridge.
Sun-Tzu
The previous rulers of the island must decide to
attack or not.
If they attack the mainland army must decide

whether to retreat or fight.
Attacking is only worthwhile if the mainland army

retreats.
Retreating is preferable to fighting for the mainland

army.
What is the unique SPNE?

Extensive Form and SPNE
M Retreat (a,d)
Attack
Fight (b,e)
PR Yield (c,f)
Payoffs: (PR’s payoff, M’s payoff)

M Retreat (a,d)
Attack
Fight (b,e)
PR Yield (c,f)

With payoffs such that a>c>b and f>d>e
M Retreat (a,d)
Attack
Fight (b,e)
PR Yield (c,f)

M Retreat (a,d)
Attack
Fight (b,e)
PR Yield (c,f)

Sun-Tzu
Suppose we add a first stage in which the mainland

army can burn the bridge.
What it is the new SPNE?

a>c>b M Retreat (a,d)
f>d>e Attack
Don’t PR Fight (b,e)
Burn Yield (c,f)
M
Attack M Fight
Burn (b,e)
PR Yield
(c,f)
f>d>e Attack
Burn Yield (c,f)
M
Attack M Fight
Burn (b,e)
PR Yield
(c,f)
f>d>e Attack
Burn Yield (c,f)
M
Attack M Fight
Burn (b,e)
PR Yield
(c,f)
f>d>e Attack
Burn Yield (c,f)
M
Attack M Fight
Burn (b,e)
PR Yield
(c,f)
f>d>e Attack
Burn Yield (c,f)
M
Attack M Fight
Burn (b,e)
PR Yield
(c,f)
Intuition
Burning the bridge makes the commitment to fight
credible
In the unique SPNE, mainland army now keeps the

island (without having to fight!)
Intuition
credible

Taking actions that remove future options provides

a commitment device.
Can help commit you to actions you would

otherwise not take.
And yield a strategic advantage.

Intuition
credible

Taking actions that remove future options provides

a commitment device.
Can help commit you to actions you would

otherwise not take.
And yield a strategic advantage.
When else might this be a valuable lesson?

Stackelberg Competition
Standard Cournot set up, except moves are sequential
Firm 1 chooses q1 .
Firm 2 observes q1 and chooses q2 .
Market output: Q = q1 + q2
Inverse demand function: P (Q) = 1 − Q
Marginal cost: c
Using Backward Induction
Suppose firm 1 has choosen q1 .
Firm 2’s problem is then:
max q2 (1 − Q − c)
q2 ≥0
1−q1 −c
From FOC: B2 (q1 ) = 2 .
This tells us what 2 chooses as a function of what 1

chose.
Using Backward Induction
Knowing this, 1 chooses q1 to solve:
max q1 (1 − q1 − B2 (q1 ) − c).

q1 ≥0
1−c
From FOC: q1 = 2 .
1−c
And so q2 = 4 .
There is a first mover advantage.

2
I π1 = 2π2 = 1−c
2
( 1+3c−4c
4
) = (1−c)
8
.
(1−c)2
I With Cournot competition π = 9 .
I So the Stackleberg leader benefits from moving first.
Market Outcomes
Under Stakelberg Competition:
3(1−c)
Q= 4
1+3c
P = 4
Under Cournot Competition:

2(1−c)
QC = 3
1+2c
PC = 3
So, output is lower and prices are higher with

simultaneous moves.
Stackelberg in Pictures
𝑞2
1
𝐵1(𝑞2)
1/2
𝐵2(𝑞1)
1/2 1
𝑞1
𝑞2
1
𝐵1(𝑞2)
1/2
1/2 1
𝑞1
𝑞2
1
𝐵1(𝑞2)
Profits
Increasing
1/2 in this
direction
1/2 1
𝑞1
𝑞2
1
𝐵1(𝑞2)
1/2
1/2 1
𝑞1
𝑞2
1
𝐵1(𝑞2)
1/2
1/2 1
𝑞1
𝑞2
1
𝐵1(𝑞2)
1/2
1/2 1
𝑞1
Differentiated Bertrand: Sequential Moves
Recall our differentiated Bertrand Model:
Unit mass of consumers located uniformly on the

unit interval.
Two firms 1, 2 with fixed locations 0 and 1
respectively choose prices p1 , p2 .
Consumer located at l ∈ [0, 1] who buys from i
located at xi gets:
v − (l − xi )2 t − pi .
Under some assumptions, indifferent consumer at
t + p2 − p1
l∗ = .
2t
Demands
0 𝑙∗ 1
Demands
1𝑙 ∗ 1(1 − 𝑙 ∗ )
0 𝑙∗ 1
Consumers closer to firm i than l∗ then buy from i, and

so demand is:
q1 (p1 , p2 ) = t+p2t2 −p1
q2 (p1 , p2 ) = t−p2t2 +p1
Suppose firm 1 chooses price first, then, after observing

this, firm 2 chooses price.
Solve by backward induction.

Suppose 1 has chosen p1
Then 2 solves:
max q2 (p1 , p2 )(p2 − c).

p2 ≥0
FOC implies that

t + p1 + c
B2 (p1 ) =
2
Anticipating 2’s response, 1’s problem is:
t+p +c
1
max q1 p1 , (p1 − c).
p1 ≥0
| {z }2
p2
t+p +c
1
max q1 p1 , (p1 − c).
p1 ≥0
| {z }2
p2
The FOC implies that:

3t + 2c
p1 = .
2
t+p +c
1
max q1 p1 , (p1 − c).
p1 ≥0
| {z }2
p2
The FOC implies that:

3t + 2c
p1 = .
2
And so,
t + c 3t + 2c 5t + 4c
p2 = + = .
2 4 4
The equilibrium profits of the two firms are:
π1 = q1 (p1 , p2 )(p1 − c)
9t
=
16
π2 = q2 (p1 , p2 )(p2 − c)
25t
=
32
With simultaneous moves p1 = p2 = pS = t + c
p1 > p2 > pS for all t > 0
p1 = p2 = pS = c for t = 0.
With simultaneous moves, π1 = π2 = πS = 2t .

π2 > π1 > πS for all t > 0
π2 = π1 = πS = 0 for t = 0.
There is a follower (second mover) advantage and

sequential moves hurt consumers.
Why the change compared to choosing quantities?
𝑡 = 1,
𝑝2 𝐵1(𝑝2) 𝑐 = 0.5
𝐵2(𝑝1)
𝑝1
𝑡 = 1,
𝑝2 𝐵1(𝑝2) 𝑐 = 0.5
𝑝1
𝑡 = 1,
𝑝2 𝐵1(𝑝2) 𝑐 = 0.5
𝐵2(𝑝1)
𝑝1
𝑡 = 1,
𝑝2 𝐵1(𝑝2) 𝑐 = 0.5
𝐵2(𝑝1)
𝑝1
Delegating to Maximizing Revenues
(you have to solve this problem in Supplementary Problem (D)).
Suppose we play a standard Cournot game, but with

a twist:
Firm 1 appoints a manager who is charged with

maximizing revenues instead of profits.
Firm 2 continues to maximize profits.

The manager of firm 1 therefore solves:
max q1 (1 − q1 − q2 ).
q1
and so:
1 − q2
B1 (q2 ) =
2
As Firm 2 still maximizes profits, Firm 2 solves:
max q2 (1 − q1 − q2 − c).
q2
and so:
1 − q1 − c
B2 (q1 ) =
2
Then, in equilibrium
1+c 1 − 2c
q1 = q2 = .
3 3
and
2
1 − 2c 1+c 1 − 2c
π1 = π2 = .
3 3 3
So the manager that maximizes revenues generates

higher profits than the manager maximizing profits!
Delegation
Now consider the following dynamic game.
Two Cournot competitors.
Boards simultaneously choose managerial incentive
contracts.
I Standard linear inverse demand Cournot competition
with fairly low marginal cost.
I P = 1 − q1 − q2 and 0 < c < 1/4.
I Incentivise managers to maximize profits or revenues.
Then managers simultaneously choose outputs.

Delegation
We’ve seen it can sometimes be best to make a

manager maximize revenues instead of profits.
Do you have some intuition for why?

Delegation
We’ve seen it can sometimes be best to make a

manager maximize revenues instead of profits.
Do you have some intuition for why?
To solve this game: backward induction.
Consider subgames in which:

I Both firms maximize profits (done).
I One maximizes profits, the other revenues (done).
I Both maximize revenues.
Delegation
Recall that if both managers maximize profits.
1−c
q1 = q 2 = .
3
and
(1 − c)2
π 1 = π2 = .
9
Delegation
Recall that if manager 1 maximizes revenues and
manager 2 maximizes profits:
1+c 1 − 2c
q1 = q2 = .
3 3
and
2
1 − 2c 1+c 1 − 2c
π1 = π2 = .
3 3 3
Delegation
Suppose both managers maximize revenues.
Manager i then solves:
max qi (1 − qi − qj ).
qi
and so:
1 − qj
Bi (qj ) =
2
Delegation
In equilibrium
1
q1 = q2 = .
3
and
1 − 3c
π 1 = π2 = .
9
Delegation
Have the following ordering of profits for Firm 1:
1 − c − 2c2

π1 (revenues, profits) =
9
>
1 − 2c + c2

π1 (profits, profits) =
9
>
1 − 3c
π1 (revenues, revenues) =
9
>
1 − 4c + 4c2

π1 (profits, revenues) = .
9
Delegation
So, at the first stage of the game:
Each board has a dominant strategy to choose

contracts that make their manager aggressive.
But in equilibrium profits are lower than they would

have been if both managers had maximized profits.
We have a prisoner’s dilemma!

Middle Men
Monopolist has zero marginal costs and chooses a

price pM to sell to an intermediary.
Intermediary chooses price pI to sell to end

consumers.
Intermediary sells a quantity

Q(pI ) = max{1 − pI , 0}.
And so must also buy Q units from the monopolist.

Stage 2
Suppose the intermediary has agreed to pay price pM to
the monopolist. The intermediary’s problem is then:
max Q(pI )(pI − pM ).

pI ≥0
Assuming an interior solution (such that Q(p∗I ) > 0 and

p∗I ≥ 0), the first order condition is:
1 + pM
pI = .
2
Stage 1
Use backward induction.
Monopolist knows the intermediary will set

1 + pM
pI = .
2
So will face demand:
1 + pM
Q(pI (pM )) = max{1 − pI , 0} = max{1 − , 0}
2
Stage 1
Monopolist’s problem is then:
max Q(pI (pM ))pM .

pM ≥0
Continuing to assume an interior solution, monopolist’s

first order condition is:
1
pM = .
2
Subgame Perfect Equilibrium
Thus
3 1
pI = and Q= .
4 4
Hence our guess that there is an interior solution is
validated.
If the monopolist had been able to sell directly to

the end customers:
I Market price: 12 .
I Market output: 12 .
Double marginalisation
Having to sell through the intermediary increases

the price consumers pay and reduces output.
This is known as double marginalisation.
Here the intermediary is a monopolist.
What do you think would have happened if there

were two intermediaries choosing their prices in the
second stage?
The Ultimatum Game
Two players: 1, 2.
First 1 proposes a split of surplus by choosing

a1 ∈ {0, . . . , 100}.
Let a2 = 100 − a1
2 then accepts or rejects the offer.
If 2 accepts, player 1 receives payoff a1 , 2 gets

a2 = 100 − a1 .
If 2 rejects, both get nothing.

The Ultimatum Game
Solve game using backward induction.
Player 2 should accept any amount

a2 = 100 − a1 > 0.
And be indifferent about accepting or rejecting

a2 = 100 − a1 = 0.
There are two (pure strategy) SPNE.
I 1 offers 0 and 2 accepts any a2 = 100 − a1 ≥ 0.
I 1 offers 1 and 2 accepts if and only if a2 = 100 − a1 > 0.
Ultimatum Game: Deviations
Why do people deviate from the SPNE?

Preference for “winning” vis-a-vis your partner?
Preference for fairness?
Rule of thumb instead of maximizing payoff?
Rejecting low offers is low cost and might benefit
society, so a good norm to have.
What would you do if I multiplied payoff by 1000?
Ultimatum Game: Continuous Offers
Suppose we let 1 propose a1 ∈ [0, 100].
There is now a unique (pure strategy) subgame

perfect equilibrium.
Player 1 proposes 100.
Player 2 accepts all offers a2 = 100 − a1 ≥ 0.
Sometimes this is an easier model to work with.
Can represent it in extensive form as follows:

Ultimatum Game—Extensive Form
Accept
(𝑎1 , 100 − 𝑎1 )
1 2
𝑎1 ∈ [0,100]
Reject
(0, 0)
The n-Player Ultimatum Game
n players 1, 2, . . . , n.
First 1 proposes a split of surplus

P choosing a vector
n
a ∈ R such that ai ≥ 0 and i ai = 100.
Then player 2, . . . , n sequentially accept or reject

the offer.
If players 2, . . . , n all accept, player i receives payoff

ai .
If any player rejects, all players get nothing.

The n-Player Ultimatum Game
Use backward induction.
If players 2, . . . , n − 1 have accepted, player n

accepts an ≥ 0.
Unique subgame perfect equilibrium is for 1 to set

a1 = 100 and aj = 0 for j 6= 1 and for all players to
accept.
Accepting is a best response in all subgames.
Why is there no subgame perfect equilibrium in

which aj > 0 for j 6= 1?
Ultimatum Game Discussion
There is an advantage to proposing.
You can put an offer on the table your partner is

just willing to accept, keeping most of the gains for
yourself.
In practice you’d have to know what is just

acceptable.
Preferences for fairness can also moderate the

proposer advantage.
Bargaining seems like more of a back-and-forth.

Alternating Offer Bargaining
Two players. 6 rounds.
Round 1:
1 makes proposal x ∈ [0, 100].
2 accepts or rejects.
If 2 accepts, payoffs are (x, 100 − x).
If 2 rejects, 2 makes a counter offer but the size of
the pie shrinks.
Round 2:
Player 2 offers y ∈ [0, 80].
If player 1 accepts, payoffs are (80 − y, y).
If 1 rejects, 1 makes a counter offer but the size of
the pie shrinks.
Round 3:
Player 1: x ∈ [0, 64].
Round 4:
Player 2: y ∈ [0, 51].
Round 5:
Player 1: x ∈ [0, 41].
Round 6:
Player 2: y ∈ [0, 33].
Solve by backward induction. Suppose indifferent players
accept.
Round 6. Player 1 gets $0. Player 2 gets $33.
accept.
Round 5: Player 1 gets $8. Player 2 gets $33.
accept.
accept.
accept.
accept.
Have a unique SPNE with payoffs (41, 59). But not what
usually gets played.
Perhaps too hard to calculate.
But biases are systematically different.
Last round subgame is the Ultimatum game.
So play here might be expected to differ.
What if there was no round 6? Who’d get the
higher payoff?
What if the game had no end? Would we get a similar
solution?
Have an infinite number of rounds.
Pie doesn’t shrink, but players discount the future.
Reaching agreement next period is as if surplus is

smaller by a factor δ.
So, looking forward, available surplus in period t is

100δ t−1 .
Given proposer, subgames are identical.
Suppose then that i’s payoff when proposer is Vi .
Cannot have a SPNE with delay.

Some intuition:
I Suppose we reach agreement in period 2.
I Then in period 1, player 1 could make 2 an offer that
would make them both better off.
In odd period subgames, 1 must offer 2, δV2 , and 2

must accept.
I 2 weakly prefers accepting by definition.
I Resolve indifference in favor of accepting.
I Anything more would leave 1 with less.
I Anything less would be rejected.
In all even periods, 2 must offer 1, δV1 , and 1 must

accept.
Thus,
V1 = (100 − δV2 )
V2 = (100 − δV1 ).
Solving these equations,
100
V1 =
(1 + δ)
100
V2 =
(1 + δ)
So, there is a subgame perfect equilibrium in which 1
100δ
offers 2 (1+δ) and 2 accepts.
As δ → 1, equilibrium payoffs are (50, 50).

Alternating Offer Bargaining: Discussion
There is a first mover advantage, but it is small for

high δ.
Can have different time preferences for the two

players.
More patient player then does better.
An alternative interpretation of δ:
I Opportunity is lost with probability 1 − δ each period.
Alternating Offer Bargaining: Discussion
Get the same outcome if proposer is selected at

random each period with probability 1/2.
If one player is selected more frequently, they get a

higher payoff.
What would happen if player 2 could commit to:

I Never accept offers giving him less than 75.
I Never make offers leaving him with less than 75.
Delegating negotiations—a discussion
Suppose you can delegate someone to conduct
negotiations on your behalf.
Formally, you play a game in which:

I You appoint someone in period 0.
I They bargain on your behalf from period 1 onwards.
Who would you like to appoint?

I Someone who is not rational and demands more than
half could be a good idea...
Delegating negotiations—a discussion
Suppose you can delegate someone to conduct
negotiations on your behalf.
Formally, you play a game in which:

I You appoint someone in period 0.
I They bargain on your behalf from period 1 onwards.
Who would you like to appoint?

I Someone who is not rational and demands more than
half could be a good idea...
I But what would happen in both parties appointed such a
person...
Outline

Game Trees
Subgame Perfection
Applications: SPNE
Repeated Games

Uncertainty
Can incorporate uncertainty by adding a new

player—nature.
Nature randomly chooses which subgame we play.
Represented by a white node.
Probability distribution assigned to nature’s choices.

Random Proposer Ultimatum Game
Accept
1 2 (𝑎1 , 100 − 𝑎1 )
𝑎1 ∈ [0,100]
1/2
Nature Reject
(0, 0)
Accept
1/2
2 1 (𝑎2 , 100 − 𝑎2 )
𝑎2 ∈ [0,100]
Reject
(0, 0)
Simultaneous Moves in Extensive Form
Seen how finite sequential move games can be
transformed into simultaneous move games.
We can go from an extensive form representation to
a normal form representation, but can we go the
other way?
Can we turn any simultaneous move game into a
sequential game?
How might we represent simultaneous moves in a
game tree?
Let players make moves that the other players do
not observe.
Matching Pennies in Extensive Form
Information set (1,0)

H
2
H (0, 1)
1 T
H (0,1)
T 2
2
T (1, 0)
What Game is This?
Information set (1,0)

H
1
H (0, 1)
2 T
H (0,1)
T 2
1
T (1, 0)
Information Sets
Information sets used to capture people not knowing

where in the game they are.
An information set for i is a set of nodes at which i

moves such that.
I At each such node i has the same actions available.
I No node in the set is a successor node to another node
in the set.
I Each action node belongs to exactly one information set.
Strategies
What is a strategy in such games?

I A complete and contingent plan of action.
I But can only be contingent on what you know!
I Mapping from each player’s information sets to actions.
I Must take the same action at all nodes in the same
information set
Subgames
What is a subgame now? What makes sense?
Each node?
Subgames
Each node? No, people do not always know which

node they are at.
Each information set?

Subgames
Each node? No, people do not always know which

node they are at.
Each information set? No, the order of moves is

arbitrary.
Otherwise different extensive forms representing

same game would have different subgames.
Start at a single node, contain all successor nodes

and no other nodes, contain only complete
information sets.
Information Sets
How many information sets? How many subgames?
What does the game represent?
2 Football (2,2)
Football
1 Theatre (0,0)
Sunny
1/8
Theatre 2 Football (0,0)
Nature Theatre (1,1)
2 Football (2,1)
Football
7/8 Theatre (0,0)
Rainy 1 2 Football (0,0)
Theatre
Theatre (1,2)
Information Sets
2 Football (2,2)
Football
1 Theatre (0,0)
Sunny
1/8
2 Football (2,1)
Football
7/8 Theatre (0,0)
Theatre
Theatre (1,2)
Information Sets
2 Football (2,2)
Football
1 Theatre (0,0)
Sunny
1/8
2 Football (2,1)
Football
7/8 Theatre (0,0)
Theatre
Theatre (1,2)
Information Sets
2 Football (2,2)
Football
1 Theatre (0,0)
Sunny
1/8
2 Football (2,1)
Football
7/8 Theatre (0,0)
Theatre
Theatre (1,2)
Information Sets
2 Football (2,2)
Football
1 Theatre (0,0)
Sunny
1/8
2 Football (2,1)
Football
7/8 Theatre (0,0)
Theatre
Theatre (1,2)
The n-Player Ultimatum Game with
Uncertainty
n players 1, 2, . . . , n.
First nature choose the value to each player of

disagreement: di ≥ 0.
But these are not observed.
1 then proposes a split of surplus

P choosing a vector
n
a ∈ R such that ai ≥ 0 and i ai = 100.
Uncertainty
Then all players observe the disagreement vector d.
Players 2, . . . , n sequentially accept or reject the

offer.
If players 2, . . . , n all accept, player i receives payoff

ai .
If any player rejects, all players get nothing.

Uncertainty
Suppose nature chooses the disagreement payoffs

independently and
I di = 0 with probability p.
I di = 100/n with probability 1 − p.
Let players accept when indifferent.

Uncertainty
If player 1 offers aj = 0 for all j 6= 1, her offer will

be accepted with probability pn−1 .
In expectation 1 gets 100pn−1
If player 1 offers aj = 100/n for all j 6= 1, her offer

will be accepted with probability 1.
In expectation 1 gets 100/n.

Discussion
1 prefers to offer 100/n to everyone if 1/n > pn−1 .
Implies that for all p < 1, there exists n̄ such that

for all n > n̄, 1 prefers to offer 100/n.
Uncertainty about what is acceptable to others can

remove the proposer advantage.
Having to satisfy many other players in the presence

of uncertainty weakens your bargaining position.
Outline

Game Trees
Subgame Perfection
Applications: SPNE
Repeated Games

Repeated Prisoner’s Dilemma
Suppose two players played the prisoners dilemma
(below) many times with each other.
Player 2
Cooperate Defect
Cooperate (2,2) (0,3)
Player 1
Defect (3,0) (1,1)
In the one shot game, dominant strategies to defect
But can we do better now?
Idea: Incentivise cooperation by punishing defection.

Repeated Prisoner’s Dilemma
A strategy is a complete and contingent plan—what
a player will do after every possible history.
Possible strategy 1: Play cooperate until other

player defects, and then defect for ever more.
Possible strategy 2: Always cooperate.
Is it a NE for player 1 to play strategy 1 and player

2 to play strategy 2?
Is it a NE for both to play strategy 1?

Formalisation
Consider a simultaneous move stage game

G = (N, {Ai }i∈N , {ui (a)}i∈N ).
Players N
Actions ai ∈ Ai for i ∈ N
Payoffs ui (a).
Formalisation
Define the T -period repeated game of G, with discount
factor δ as a extensive form game with:
Players N
Strategy for i: action ai ∈ Ai at every information
set for i.
Payoffs:
T
X
1 2 T
Ui (a , a , . . . , a ) = δ t−1 ui (at ),
t=1
where at ∈ A.
Formalisation
Special type of extensive form game, which we have

already studied.
Discount factor allows us to incorporate time

preferences.
Can also think of it as the interest rate.

Infinite Repetitions
The infinitely repeated game is defined analogously.
Sometimes will be interested in the limit as people

become patient (δ → 1).
But then payoffs become infinitely large.
Can multiply (rescale) all payoffs by (1 − δ) to

prevent this.
These new payoffs represent the same underlying

preferences.
Finitely Repeated Prisoner’s Dilemma
Suppose there are T repetitions.
How can we find the SPNE?

Finitely Repeated Prisoner’s Dilemma
Suppose there are T repetitions.
How can we find the SPNE? Backward induction.
Dominant to defect in subgame starting in period

T.
Knowing this both players defect in period T − 1,

etc.
Unique SPNE in which all players always defect.

Strategies
Can think about strategies in terms of histories

instead of information sets.
History in period t is the sequence of action profiles

played up to period t.
Strategy for i is a mapping from every possible

history of play to a probability distribution over
actions Ai .
Strategies: Infinitely Repeated Prisoner’s
Dilemma
Always defect.
Grim trigger: Cooperate until a first defection by
the other player, and then always defect.
Finite punishment: Cooperate until a defection by
the other player, then play defect for k periods, then
return to cooperating (i.e., cooperate again until a
defection by the other player, then defect for k
periods as before, and so on).
Many others.
Nash equilibria: Infinitely Repeated
Playing a stage game Nash equilibrium after all
histories is always a Nash equilibrium.
So for the prisoner’s dilemma (always defect, always

defect) is a Nash equilibrium.
(Grim trigger, Grim trigger) is also a NE for
sufficiently high δ.
1
I On path always cooperate: Ui = 1−δ 2
δ
I Defection yields, at best, Ui = 3 + 1−δ .
I So we have a NE if and only if
1
δ ≥
2
Nash equilibria: Infinitely Repeated
(Grim trigger, Finite punishment for k periods) is also a
NE for δ, k sufficiently high.
2 plays finite punishment for k periods.

If 1 defects, play returns to normal after k periods.
During the k periods, best 1 can do is to defect.
If defection for these k periods is unprofitable, no
deviating strategy is profitable.
Repeated defection just scales the payoff difference
up or down.
Possible Payoffs
What are the feasible payoffs obtainable by some

strategy profile?
Work with the Prisoner’s Dilemma:

Player 2
Cooperate Defect
Cooperate (2,2) (0,3)
Player 1
Defect (3,0) (1,1)
Possible Payoffs
A pair of (pure) strategies results in a sequence of
stage game outcomes.
Label the possible stage game outcomes for i as

xt ∈ {a, b, c, d}
Consider payoffs for a sequence x1 , x2 , . . . given by:

∞
X
(1 − δ) δ t−1 u(xt ).
t=1
Possible Payoffs
Example: Always play a. Then i’s payoff is:
∞
X ∞
X
t−1
(1 − δ) δ u(a) = (1 − δ) δ t u(a) = u(a)
t=1 t=0
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
Example: Alternating between outcomes a and b
So a is played in odd periods and b is played in even

periods.
Then i’s payoff is

∞
X 1 δ
(1 − δ) δ t−1 u(xt ) = u(a) + u(b)
t=1
1+δ 1+δ
As δ → 1, we get u(a)/2 + u(b)/2.

Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
As δ → 1, the payoffs of the players will be a

weighted average of their stage game payoffs.
Can get any weights on a pair of payoffs by varying

the frequencies appropriately.
Similarly can get any weighted averages of the stage

game payoffs (not just pairs of them) as δ → 1.
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Nash Equilibrium Payoffs
Which sequences of actions can be played on path
in a Nash equilibrium (for sufficiently high δ)?
How about both Cooperate in even period and both
defect in odd periods?
defect in odd periods? Yes.
I Grim trigger with this cooperation phase.
I Payoff from deviating goes to (Defect, Defect) payoff as
δ → 1.
δ → 1.
How about (Cooperate, Defect) in even period and

(Defect, Cooperate) in odd periods?
δ → 1.
How about (Cooperate, Defect) in even period and

(Defect, Cooperate) in odd periods? Yes.
How about (Cooperate, Defect) in all periods?

How about (Cooperate, Defect) in all periods? No.

I Player 1 could do better always defecting.
I Each player can guarantee the (defect,defect) payoff.
I So they must get at least this in the cooperation phase.
Possible Nash Equilibrium Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
𝑈2
3
2
1
1 2 3 𝑈1
We have ruled out some feasible payoffs as possible

Nash equilibrium payoffs.
Are all other payoffs obtainable in equilibrium for

sufficiently high δ?
We have ruled out some feasible payoffs as possible

Nash equilibrium payoffs.
Are all other payoffs obtainable in equilibrium for

sufficiently high δ? Yes!
Via grim trigger strategies.

New Game 1
Player 2
A B C
A (2,2) (0,3) (0,0)
Player 1
B (3,0) (1,1) (0,0)
C (0,0) (0,0) (0,0)
Can now use C as a punishment.
Grim trigger with C as a punishment can sustain

any feasible payoff.
𝑈2
3
2
1
1 2 3 𝑈1
𝑈2
3
2
1
1 2 3 𝑈1
𝑈2
3
2
1
1 2 3 𝑈1
New Game 2
Player 2
A B C
A (2,2) (0,3) (0,0)
Player 1
B (3,0) (1,1) (0,0)
Player 2 can use C as a punishment.
But the harshest punishment Player 1 can use is to

play B.
And player 2 can guarantee at least 1 by playing B.
All feasible payoffs in which 2 gets at least 1 are

possible in a NE.
Obtained by using grim trigger strategies with these

punishments.
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Possible Payoffs
𝑈2
3
2
1
1 2 3 𝑈1
Folk Theorem
Finding the payoffs that can be achieved comes
down to finding the harshest possible punishment.
What are these in general?
The worst payoff player 1 can impose on player 2 is:

min max u2 (a1 , a2 )
a1 ∈A1 a2 ∈A2
Obtained through grim-trigger in which player 1

punishes a deviation by 2 by thereafter playing
argmin max u2 (a1 , a2 ).
a1 ∈A1 a2 ∈A2
Folk Theorem
Folk Theorem: In the limit, as δ → 1, a payoff vector

can be obtained in a Nash equilibrium if and only if it is
(i) feasible; and
(ii) all players receive more than their minmax payoff.
Subgame Perfection
Are min max punishments credible?
Sometimes, but not always.

New Game 2
Player 2
A B C
A (2,2) (0,3) (0,0)
Player 1
B (3,0) (1,1) (0,0)
Subgame Perfection
In New Game 2, 2’s threat to choose C was not

credible.
When playing C in the punishment subgame, 2 has

a profitable deviation.
New Game 1
Player 2
A B C
A (2,2) (0,3) (0,0)
Player 1
B (3,0) (1,1) (0,0)
C (0,0) (0,0) (0,0)
Subgame Perfection
But, in New Game 1, it is credible for both players
to use C.
In this game (C, C) is a Nash equilibrium of stage

game.
Paying a Nash equilibrium of a stage game for ever

more is always a NE of the repeated game.
Strategies that threaten to play a Nash equilibrium

action for ever more after a deviation are called
Nash reversion strategies.
Nash reversion is always a credible threat and so can

be used in a SPNE.
Subgame Perfection
Consider the following version of grim trigger
strategies in New Game 1.
In round t player i plays A if in all previous rounds
only A has ever been played by either player, and
otherwise plays C.
If players i = 1, 2 both play this strategy, this is a
SPNE for all δ sufficiently high.
On path both players always then play A.
Off path, following a deviation by any player to
anything in period t, both players expect the other
to play C forevermore, and so are best responding
by also choosing C forevermore.
Finite Repetitions: A Comment
If we play the prisoner’s dilemma T times there is a

unique SPNE.
We get the stage game NE payoff each period by

backward induction.
More generally, can we ever do better than the

stage game NE payoffs?
If we play the prisoner’s dilemma T times there is a

unique SPNE.
We get the stage game NE payoff each period by

backward induction.
More generally, can we ever do better than the

stage game NE payoffs? Yes!
When there are multiple NE we can use this

multiplicity to punish.
New Game 3
Consider the following game
Player 2
A B C
A (2,2) (0,3) (-1,-1)
Player 1
B (3,0) (1,1) (-1,-1)
C (-1,-1) (-1,-1) (-1,-1)
Suppose both players played the following strategy:
For t < T play A if j has always played A,

otherwise play C.
In period T play B if j has always played A,
otherwise play C.
For δ sufficiently high, this is a SPNE.
And on path (A, A) is played until the last period in

which (B, B) is played
Outline

Two alternatives
More than two alternatives
Relaxing Arrow’s Axioms
Reformulating Arrow’s Problem
Social Choice Theory: Readings
List, Christian. “Social Choice Theory.” Stanford

Encyclopedia of Philosophy (2013) (Sections 1-4).
Sen, Amartya. “The possibility of social choice.”

The American Economic Review 89.3 (1999):
349-378.
Social Choice Theory
Study of collective decision making.
How do we map individual level inputs

(e.g., votes, preferences, judgement, welfare)
into collective outputs

(e.g., decisions, preferences, judgements, welfare)?
Key questions
How can a group of individuals choose a collective
outcome (e.g., policy, electorial candidate)?
How can a group of individual reach a collective

judgement on an issue based on their individual
judgements?
What properties do different voting systems have?
How can we rank different social choices in terms of

social welfare?
An Example
Suppose a country has to decided whether to remain

part of a union with other countries.
Is there a good way in which a collective decision
can be taken?
How would you go about designing a system to

make the decision?
Based on what principles?

Outline

Two alternatives
One option: Voting
Individuals N = {1, 2, . . . , n}.
Collective choice: 2 alternatives (e.g., stay or leave
union)
Each individual castes a vote vi where

1
 indicates prefernces for exiting
vi = −1 indicates prefernces for staying

0 indicates abstention
Let (v1 , . . . , vn ) be a profile of votes.

Social Decisions
A social decision is a function f from {1, 0, −1}n

mapping into {1, 0, −1}.
We set v = f (v1 , . . . , vn ).
How might we choose f (·)?
Some possibilities:
I Majority Rule
I Super Majority
I Weighted Majority
I Dictatorship
Formalization
Majority Rule:
 P
1 if vi > 0
Pi


v= 0 if i vi = 0

−1 otherwise
Formalization
Majority Rule:
 P
1 if vi > 0
Pi


v= 0 if i vi = 0

−1 otherwise
Supermajority:
 P
1
 if
Pi
vi > k
v= 0 if i vi = k

−1 otherwise
for some k > 0

Formalizing Weighted Majority Rule
Weighted Majority Rule:
 P
1
 if
Pi
wi vi > 0
v= 0 if i wi vi = 0

−1 otherwise
where wi ∈ R is the weights of person i.

Formalizing Weighted Majority Rule
Weighted Majority Rule:
 P
1
 if
Pi
wi vi > 0
v= 0 if i wi vi = 0

−1 otherwise
where wi ∈ R is the weights of person i.
Dictatorship: 
1
 if vi = 1
v= 0 if vi = 0

−1 otherwise
for a fixed i.
Social Decisions
A social decision can depend on identities.
For 3 people, how many rules are there?

Social Decisions
I There are 33 possible vote profiles.

I More generally, with n people, 3n possibilities.
I We need to partition these profiles into three, possibly
empty, sets.
I How many ways are there of doing that?
Social Decisions
I There are 33 possible vote profiles.

I More generally, with n people, 3n possibilities.
I We need to partition these profiles into three, possibly
empty, sets.
I How many ways are there of doing that?
I Lots!
I What happens as we add people
We need some way of refining the options.

Axiomatic Approach
Define properties the rule should have.
Show these properties identify a class of rules (and

ideally a unique rule).
Axiomatic Approach
Define properties the rule should have.
Show these properties identify a class of rules (and

ideally a unique rule).
Definition (Universal domain)

The domain of admissible inputs for the aggregation rule
(social decision function) consists of all possible vote
profiles (v1 , . . . , vn ).
Universal Domain Example
Suppose there are two people. The set of possible voting
profiles is then:
Possible voting profiles

Person 1 1 1 1 0 0 0 -1 -1 -1
Person 2 1 0 -1 1 0 -1 1 0 -1
Universal domain implies that we include all these
possibilities.
Is a lot of alternatives when there are many people!
In some situations we might be able to restrict the

domain.
Axiomatic Approach
Definition (Anonymity)
If there are two admissible voting profiles (v1 , . . . , vn )
and (w1 , . . . , wn ) that are permutations (reorderings) of
each other, then the same social decision is made in both
cases:
Axiomatic Approach
Definition (Anonymity)
and (w1 , . . . , wn ) that are permutations (reorderings) of
each other, then the same social decision is made in both
cases: f (v1 , . . . , vn ) = f (w1 , . . . , wn ).
Anonymity Example
three people
one vote for, one against and one abstention.
Social choice rule is a function f mapping individual

votes into social outcomes such that
7→ social choice.
f (1’s vote, 2’s vote, 3’s vote) |{z}
maps to
Anonymity: social choice is same regardless of who voted

for which alternative:
f (1, 0, −1) = f (1, −1, 0) = f (0, 1, −1) = f (0, −1, 1) = f (−1, 1, 0) = f (−1, 0, 1).
Axiomatic Approach
Definition (Neutrality)
and (−v1 , . . . , −vn ), then the opposite social decisions
are made:
Axiomatic Approach
Definition (Neutrality)
and (−v1 , . . . , −vn ), then the opposite social decisions
are made: f (v1 , . . . , vn ) = −f (−v1 , . . . , −vn )
Neutrality Example
Two people.
Three choices
I vote for a policy
I abstain
I vote against the policy.
Suppose the social choice rule has the following
properties:
f (1, 1, 0) = 1
f (1, 0, 0) = 1
Neutrality Example
f (1, 1, 0) = 1
f (1, 0, 0) = 1
1 and 2 vote yes, 3 abstains → implement policy.

1 votes yes, 2 and 3 abstain → implement policy.
Then, by neutrality,
f (−1, −1, 0) = −1
f (−1, 0, 0) = −1.
Neutrality Example
f (−1, −1, 0) = −1
f (−1, 0, 0) = −1
1 and 2 vote no, 3 abstains → don’t implement

policy.
1 votes no, 2 and 3 abstain → don’t implement
policy.
Can we ever have f (0, 0, 0) = 1 in a social choice rule

that satisfies neutrality?
Neutrality Example
f (−1, −1, 0) = −1
f (−1, 0, 0) = −1
1 and 2 vote no, 3 abstains → don’t implement

policy.
1 votes no, 2 and 3 abstain → don’t implement
policy.
Can we ever have f (0, 0, 0) = 1 in a social choice rule

that satisfies neutrality? No.
Axiomatic Approach
Definition (Positive Responsiveness)
For any admissible voting profile (v1 , . . . , vn ), if some of the people
change their vote in favor of one alternative (e.g., from -1 to 1 or
from 0 to 1) and all other votes remain the same, then
(i) the social decision does not change in the opposite direction
(e.g., if the social decision was 1 and the changes were in favor
of 1, the social decision must still be 1); and
(ii) if prior to the change the social decision was a tie, the social
decision changes to being in favor of the alternative people
change their vote in favor of (e.g., if the social decision was 0
and the changes were in favor of 1, the social decision must
change to 1).
Axiomatic Approach
More formally:
Definition (Positive Responsiveness)
For any admissible voting profile (v1 , . . . , vn )
(i) if f (v1 , . . . , vn ) = 1 and wi ≥ vi for all i, then
f (w1 , . . . , wn ) = 1.
(ii) if f (v1 , . . . , vn ) = −1 and wi ≤ vi for all i, then
f (w1 , . . . , wn ) = −1.
(iii) if f (v1 , . . . , vn ) = 0 and wi ≥ vi for all i and strict
for some i, then f (w1 , . . . , wn ) = 1.
(iv) if f (v1 , . . . , vn ) = 0 and wi ≤ vi for all i and strict
for some i, then f (w1 , . . . , wn ) = −1.
Positive Responsiveness Examples
Consider the following profile of votes: (1, −1, 1, −1, 1)
and suppose f (1, −1, 1, −1, 1) = 1.
Then do the following hold by positive responsiveness?
f(1,1,1,-1,1) = 1
f(1,1,-1,1,1) = 1
f(1,0,1,0,1) = 1
f(1,0,1,1,1) = 1
f(1,0,1,1,0) = 1
f(-1,-1,-1,-1,-1) = -1
and suppose f (1, −1, 1, −1, 1) = 1.
f(1,1,1,-1,1) = 1 Yes
f(1,1,-1,1,1) = 1
f(1,0,1,0,1) = 1
f(1,0,1,1,1) = 1
f(1,0,1,1,0) = 1
f(-1,-1,-1,-1,-1) = -1
and suppose f (1, −1, 1, −1, 1) = 1.
f(1,1,1,-1,1) = 1 Yes
f(1,1,-1,1,1) = 1 No
f(1,0,1,0,1) = 1
f(1,0,1,1,1) = 1
f(1,0,1,1,0) = 1
f(-1,-1,-1,-1,-1) = -1
and suppose f (1, −1, 1, −1, 1) = 1.
f(1,1,1,-1,1) = 1 Yes
f(1,1,-1,1,1) = 1 No
f(1,0,1,0,1) = 1 Yes
f(1,0,1,1,1) = 1
f(1,0,1,1,0) = 1
f(-1,-1,-1,-1,-1) = -1
and suppose f (1, −1, 1, −1, 1) = 1.
f(1,1,1,-1,1) = 1 Yes
f(1,1,-1,1,1) = 1 No
f(1,0,1,0,1) = 1 Yes
f(1,0,1,1,1) = 1 Yes
f(1,0,1,1,0) = 1
f(-1,-1,-1,-1,-1) = -1
and suppose f (1, −1, 1, −1, 1) = 1.
f(1,1,1,-1,1) = 1 Yes
f(1,1,-1,1,1) = 1 No
f(1,0,1,0,1) = 1 Yes
f(1,0,1,1,1) = 1 Yes
f(1,0,1,1,0) = 1 No
f(-1,-1,-1,-1,-1) = -1
and suppose f (1, −1, 1, −1, 1) = 1.
f(1,1,1,-1,1) = 1 Yes
f(1,1,-1,1,1) = 1 No
f(1,0,1,0,1) = 1 Yes
f(1,0,1,1,1) = 1 Yes
f(1,0,1,1,0) = 1 No
f(-1,-1,-1,-1,-1) = -1 No
and suppose f (1, −1, 1, −1, 1) = 0.
f(1,1,1,-1,1) = 1
f(1,0,1,1,0) = 1
f(1,0,1,0,1) = 1
f(1,-1,0,-1,1) = -1
f(1,-1,1,1,-1) = 0
and suppose f (1, −1, 1, −1, 1) = 0.
f(1,1,1,-1,1) = 1 Yes
f(1,0,1,1,0) = 1
f(1,0,1,0,1) = 1
f(1,-1,0,-1,1) = -1
f(1,-1,1,1,-1) = 0
and suppose f (1, −1, 1, −1, 1) = 0.
f(1,1,1,-1,1) = 1 Yes
f(1,0,1,1,0) = 1 No
f(1,0,1,0,1) = 1
f(1,-1,0,-1,1) = -1
f(1,-1,1,1,-1) = 0
and suppose f (1, −1, 1, −1, 1) = 0.
f(1,1,1,-1,1) = 1 Yes
f(1,0,1,1,0) = 1 No
f(1,0,1,0,1) = 1 Yes
f(1,-1,0,-1,1) = -1
f(1,-1,1,1,-1) = 0
and suppose f (1, −1, 1, −1, 1) = 0.
f(1,1,1,-1,1) = 1 Yes
f(1,0,1,1,0) = 1 No
f(1,0,1,0,1) = 1 Yes
f(1,-1,0,-1,1) = -1 Yes
f(1,-1,1,1,-1) = 0
and suppose f (1, −1, 1, −1, 1) = 0.
f(1,1,1,-1,1) = 1 Yes
f(1,0,1,1,0) = 1 No
f(1,0,1,0,1) = 1 Yes
f(1,-1,0,-1,1) = -1 Yes
f(1,-1,1,1,-1) = 0 No
Characterization
These four axioms characterize a social decision rule.

Which one?
Theorem (May 1952)

A social decision rule satisfies universal domain,
anonymity, neutrality and positive responsiveness if and
only if it is
Characterization
These four axioms characterize a social decision rule.

Which one?
Theorem (May 1952)

A social decision rule satisfies universal domain,
anonymity, neutrality and positive responsiveness if and
only if it is majority rule.
Intuition
Anonymity implies that all votes are equal and only

the distribution of votes matters.
Neutrality then implies only the sum of votes

matters
Positive responsiveness implies that votes count in

the right direction and so the alternative with most
votes wins.
Discussion
Does the theorem mean that majority rule is better

than alternatives?
Which axioms do other voting rules violate?
Helps us understand the differences between the

voting rules.
Are there any other axioms we’d like to be satisfied?

Aggregation of Information
Suppose we interpret the choice as being based on a
procedure independent fact.
e.g., a jury has to decide the innocence or guilt of a

defendant.
Let X = 1 represent the defendant being guilty
Let X = −1 represent the defendant being innocent
Individual votes express a judgement about the true

value of the random variable X.
Societal goal: Reach the correct judgement.

Condorcet’s Jury Theorem
Assume:
1. Different judgements are stochastically independent,
given the true state.
2. Each individual’s judgement is better than random
Under these two assumptions, majority voting is good at

reaching the correct judgement.
Formalization
Let V1 , . . . , Vn be the random variables generating
individual votes.
As the votes are random, so is the outcome.
Let the random social outcome be V = f (V1 , . . . , Vn ).
Definition (Competence)
For all i ∈ N and all states of the world x ∈ {−1, 1},
P r(Vi = x|X = x) = p > 1/2 (where p is constant
across states and individuals).
Competence Example
Suppose I fill a jar with pound coins and 104 fit in.
I then ask people to guess whether there are more or less

than 100 pound coins in the jar.
I might think about each person’s guess as a random

variable.
Competence requires that each person’s guess is more

likely to be correct than incorrect.
Competence Example
Likewise, suppose I filled many jars with pound coins,

some with more and some with less than 100.
I now asked the same person to guess more or less for

each jar
As long as I have enough jars, competence implies the

person will be correct more than half the time.
Formalization
Definition ((Conditional) Independence)

For all i 6= j and all x ∈ {−1, 1}, P r(Vi = x ∩ Vj =
y|X = z) = P r(Vi = x|X = z)P r(Vj = y|X = z).
Conditional independence
Let’s go back to the glass jar with pound coins.
Conditional independence says that, given there are 104

pound coins in each jar, individual guesses should be
independent.
Probability 1 guesses more and 2 guesses less, given 104,

is the probability 1 guesses more given 104 multiplied by
the probability 2 guesses less given 104.
Would this make sense if people observed each other’s

choices?
Conditional independence
Let’s go back to the glass jar with pound coins.
Conditional independence says that, given there are 104

pound coins in each jar, individual guesses should be
independent.
Probability 1 guesses more and 2 guesses less, given 104,

is the probability 1 guesses more given 104 multiplied by
the probability 2 guesses less given 104.
Would this make sense if people observed each other’s

choices? Probably not.
Formalization
Theorem (Condorcet’s Jury Theorem)

For each state of the world x ∈ {1, −1}, given
independence and competence the probability of a
correct majority decision P r(V = x|X = x) is greater
than each individual probability of a correct vote
P r(Vi = x|X = x), and converges to 1 as n increases.
Discussion
Theorem dates back to the 18th Century.
Represents the wisdom of the crowd.
Are the assumptions of independence and

competence reasonable?
If the assumptions do not hold, is the conclusion

always false?
When might the theorem fail?

Another property of Majority rule
Minimizes the number of loosing voters.

Another property of Majority rule
Minimizes the number of loosing voters.
So we have three arguments for majority rule:
Only rule that satisfied a set of desirable properties.
Good way of correctly aggregating information.
Minimizes the number of frustrated voters.

Outline

Two alternatives
Social Choice Solved?
So we are done?
We have a system that works well in many ways.
Sometimes something else might be warranted, but

we have a framework for guiding our thinking.
Social Choice Solved?
So we are done?
We have a system that works well in many ways.
Sometimes something else might be warranted, but

we have a framework for guiding our thinking.
We only considered choices between two items, but

can’t we generalize to k > 2 choices?
How should we choose between k > 2 alternatives?
Do we want people to pick their best choice only or

provide a complete preference ordering?
How do we turn these inputs into a social choice?
Just using majority rule throws away valuable

information.
And has some undesirable properties. What might

go wrong?
A Choice Theory Approach
Can frame the question somewhat differently.
How should we aggregate preferences.
We have a good way of making pairwise

comparisons between social alternatives.
So why not use this to create a social preference

relation and make choices based on this.
It worked for individual decisions!

Preference Aggregation
Set of alternatives X = {x, y, z, . . . }.
Set of rational people N = {1, . . . , n}.
Is there a simple way to aggregate these

preferences?
If we can construct a societal preference ordering that is

also rational, then we can use individual choice theory to
study social decision making.
Recap: Individual Preferences
Notation:
Let x i y represent person i weakly preferring the
alternative x to y.
If x i y and y i x, then we say i is indifferent
between x and y: x ∼i y.
If x i y and y 6i x, then we say i strictly prefers x
to y: x i y.
Recap: Rationality
What do we mean by rational people?

Recap: Rationality
What do we mean by rational people?
Preferences that are:

Complete: For all i and all x, y ∈ X, either x i y
or y i x.
Reflexive: For all i and all x ∈ X, x i x.
Transitive: For all i and all x, y, z ∈ X, if x i y
and y i z, then x i z.
Recap: Choices
What do we know about rational choices? Why might it
be useful for our societal preferences to be rational?
Let C(X; ) be the most preferred choices from the set

X given preferences :
C(X, ) = {x ∈ X : x y for all y ∈ X}

(all x in X such that x is weakly preferred to everything else in X)
Given alternatives X, we’d like to choose something that

is most preferred.
Rationality implies that we can make such a choice:

C(X; ) 6= ∅.
Aggregating Preferences
From individual preferences we want to construct societal
preferences. How might we do that?
Aggregating Preferences
From individual preferences we want to construct societal
preferences. How might we do that?
Let society weakly prefer the outcome x to y, if weakly
more people prefer x to y:
xy if and only if |{i : x i y}| ≥ |{i : y i x}|
Resulting society preferences are complete and reflexive.

Why?
Are they also transitive?
Two alternatives
With two alternatives, preferences are transitive too.
Two alternatives
Society prefers choices that most people prefer: We are

back to majority rule.
Two alternatives

Majority rule, in this case, can be viewed as constructing

societal preferences as described and then applying
choice theory to these preferences.
Two alternatives


What about with more choices?

Two alternatives


What about with more choices?
Condorcet advocated the use of this approach, but also

found the key limitation.
An example
Suppose there are three outcomes: X = {x, y, z}.
And three people: N = {1, 2, 3}.
With rational preferences that include the following:

Person 1: x 1 y 1 z.
Person 2: z 2 x 2 y.
Person 3: y 3 z 3 x.
What are societal preferences between x and y?

Condorcet Paradox
Using the aggregation rule, we have:

x y.
y z.
z x.
This is called a Condorcet cycle.
The aggregation of rational individual preferences, can

lead to irrational societal preferences.
Is this a big problem?
Perhaps such situations are very unusual?
Unfortunately not, the probability of intransitivities

increases with the number of people and
alternatives.
If all preference profiles were equally likely,

intransitivities are probable in large elections.
Is this a big problem?
Perhaps such situations are very unusual?
Unfortunately not, the probability of intransitivities

increases with the number of people and
alternatives.
If all preference profiles were equally likely,

intransitivities are probable in large elections.
Some other system for aggregating preferences

could work well.
Alternative systems
We have seen that perhaps the most natural
method of aggregation doesn’t work well.
Space of alternatives is very large, so how can we
ever rule out or in the existence of a good system?
Alternative systems
Might use our intuition to guess a good system.
If we are right, and show it works well, then we’d be
done.
Alternative systems
Might use our intuition to guess a good system.
If we are right, and show it works well, then we’d be
done.
But this approach didn’t lead to all that much
progress. What if nothing good exists?
Proof by brute force (exhaustive search) is infeasible.
Back to first principles
A voting rule is a way of aggregating preferences.
Let’s ask directly about the existence of a good

system of any kind for aggregating preferences.
But first we need to define what good means.
We need axioms!
Axiomatic methodology
Let F be our function for aggregating preferences.
So F maps from individual preference relations

{i }i∈N into a societal preference relation .
Will make our search more systematic.
Could help us find something good.

Universal Domain
Definition (Universal Domain)

The domain of F is the set of all possible rational
individual preference relations.
Relatively uncontroversial as a generally desirable

property.
In some cases, however, there might be natural
restrictions we can make without too much loss.
Universal Domain Example
People now have preferences over more alternatives and
entire ordering matters.
Suppose there are three alternatives, {a, b, c}.
Even considering just strict preferences we have:

Possible preference profiles
1’s most preferred a a b b c c a a ... c
1’s next best b c a c a b b c ... b
1’s worst c b c a b a c b ... a
2’s most preferred a a a a a a a a ... c
2’s next best b b b b b b c c ... b
2’s worst c c c c c c b b ... a
Ordering
Definition (Ordering)
For any admissible individual preference profile
(1 , . . . , n ) the societal preference relation is rational.
We can order alternatives when a preference relation

is rational.
Recall that rationality guarantees that there is at
least one best choice.
If there is no best choice, what should a social
choice rule do?
Ordering Example
Suppose there are three alternatives and two people and
individual preferences are:
a 1 b 1 c
a 2 c 2 b
We might be tempted to give society preferences:

ab
ac
But not order b and c.
Ordering Example
Our proposed ordering is the Pareto ordering.
An alternative x Pareto dominates y if and only if

everyone weakly prefers x to y and someone strictly
prefers x to y.
Pareto Ordering: Society prefers x to y if and only
if it Pareto dominates y.
But this ordering is incomplete.
So not allowed under ordering.

Ordering Example
We could have:
ab
ac
bc
c b.
But we’ll see this has other problems later.

Weak Pareto Principle
Definition (Weak Pareto Principle)

For any admissible individual preference profile
(1 , . . . , n ), if x i y for all i, then x y.
At a minimum shouldn’t society prefer an

alternative that everyone prefers?
Seems uncontroversial.
Weak Pareto Principle Example
Suppose (again) there are three alternatives and two
people and individual preferences are:
a 1 b 1 c
a 2 c 2 b
The weak Pareto principle requires that society

preferences rank a above b and c:
ab
ac
Doesn’t say anything about the ordering of b and c
Independence of Irrelevant Alternatives
Definition (IIA)
For any two admissible individual preference profiles
ˆ 0n ) and any x, y ∈ X, if
(1 , . . . , n ) and (01 , . . . ,
x i y if and only if x 0i y for all i ∈ N , then x y if
and only if x 0 y.
If there are two (sets of) preference relations which give

each person the same ordering over x and y, then the
societal preferences derived from both these preference
relations should order x and y in the same way.
IIA
Implies that individual orderings of alternative

choices z ∈ X don’t affect society’s preference over
x and y.
For society’s ordering of x and y, all that matters is

individual preferences over x and y.
Possibly the most controversial axiom, but still

seems fairly natural.
IIA Example
Suppose there are two people who have preferences
a 1 b 1 c
b 2 c 2 a
and society has preferences b a.
Then, were the two people to instead have preferences

a 01 c 01 b
b 02 a 02 c
we’d require society to still have preferences b 0 a.
Non-dictatorship
Definition (Non-dictatorship)
There does not exist an individual i ∈ N such that for all
admissible individual preference profile (1 , . . . , n ) and
all x, y ∈ X, x y if and only if x i y.
Societies preferences cannot simply be determined

by one individual.
After all, we are studying an aggregation problem.
Non-Dictatorship Example
Under non-dictatorship we cannot have societal
preferences such that
x y if and only if x 1 y,
for any preference 1 might have.
Suppose, a 1 b 1 c.
We can have a b c because this is one instance in
which societies preferences match 1’s preferences.
Non-dictatorship requires that societies preferences don’t
always match one person’s preferences.
Arrow’s Impossibility Theorem
Theorem (Arrow 1951/1963)

If |X| > 2, then there exists no preference aggregation
rule satisfying universal domain, ordering, the weak
Pareto principle, independence of irrelevant alternatives
and non-dictatorship.
Discussion
Can be applied to other problems. For example:

I Belief orderings over hypotheses.
I Multidimensional individual decisions.
Follow up work shows that the axioms can even be

weakened without changing the conclusions.
Discussion
Viewed by many, especially at the time, as the end

of social choice theory.
Mathematically, if you accept:

(i) the formulation (primitives of the problem); and
(ii) the axioms as being required,
there is no escaping the conclusions.
So lets evaluate these things more carefully.

Outline

Two alternatives
A1: Universal Domain
Restrict preferences in certain ways, we can

eliminate Condorect cycles.
Pairwise majority voting then generates transitive

social preferences.
Restrictions require some level of common

agreement or cohesion.
Good example, is single peakedness (Black, 1948).

Single Peakedness
Definition (IIA)
An individual preference profile (1 , . . . , n ) satisfies
single peakedness if alternatives can be ordered such that
each individual has a most preferred choice and prefers
things closer to this idea point.
Single Peakedness
Definition (IIA)
single peakedness if alternatives can be ordered such that
each individual has a most preferred choice and prefers
things closer to this idea point.
Can make sense when preferences are driven by a single

thing that can be ordered—e.g., how liberal or
conservative a candidate/policy is.
Example
Suppose N = 1, . . . , 5 and X = {a, b, c, d, e}. If:
d 1 c 1 b 1 a 1 e
c 2 b 2 a 2 d 2 e
a 3 b 3 c 3 d 3 e
c 4 d 4 b 4 e 4 a
e 5 d 5 c 5 b 5 a
Are these preferences single peaked?

Single Peakeness in Pictures
Suppose we assigned each person a utilities to represent
their preferences:
A B C D E
their preferences:
A B C D E
their preferences:
A B C D E
their preferences:
A B C D E
their preferences:
A B C D E
Example 2
Suppose N = 1, . . . , 5 and X = {a, b, c, d, e}. If:
d 1 e 1 b 1 a 1 c
e 2 b 2 a 2 d 2 c
a 3 b 3 e 3 d 3 c
e 4 d 4 b 4 c 4 a
c 5 d 5 e 5 b 5 a
Are these preferences single peaked?

Single Peaked Now?
A B C D E
Single Peaked Now?
A B C D E
Single Peaked Now?
A B C D E
Single Peaked Now?
A B C D E
Single Peaked Now?
A B C D E
Single Peakedness
Definition (Single Peakedness)

single peakedness if alternatives can be ordered
such that each individual has a most preferred choice
and prefers things closer to this idea point.
Reordering the Domain
A B E D C
A B E D C
A B E D C
A B E D C
A B E D C
Condorcet Winners
Definition (Condorcet Winner)

A choice x ∈ X is a Condorcet winner if and only if for
all y ∈ X, |{i : x i y}| ≥ |{i : y i x}|.
Condorcet Winners
Definition (Condorcet Winner)

A choice x ∈ X is a Condorcet winner if and only if for
all y ∈ X, |{i : x i y}| ≥ |{i : y i x}|.
A Condorcet winner is preferred by the majority of

people to every alternative.
Makes social choice relatively straightforward.

Same Example
Is there a Condorcet winner? If so which one?
d 1 c 1 b 1 a 1 e
c 2 b 2 a 2 d 2 e
a 3 b 3 c 3 d 3 e
c 4 d 4 b 4 e 4 a
e 5 d 5 c 5 b 5 a
Median Voter Theorem
Single peakedness implies ordering of the domain.
Implies ordering of voters by their most preferred choices.
Median voter—voter with the median most preferred
choice.
To avoid technical difficulties, suppose N is odd.
Theorem (Median Voter Theorem, Black 1948)

If individual preferences are single peaked, the median
voter’s most preferred choice is a Condorcet winner.
Same Example
d 1 c 1 b 1 a 1 e
c 2 b 2 a 2 d 2 e
a 3 b 3 c 3 d 3 e
c 4 d 4 b 4 e 4 a
e 5 d 5 c 5 b 5 a
Same Example
d 1 c 1 b 1 a 1 e
c 2 b 2 a 2 d 2 e
a 3 b 3 c 3 d 3 e
c 4 d 4 b 4 e 4 a
e 5 d 5 c 5 b 5 a
Yes, c.
Same Example
Ordered, most preferred choices: (a, c, c, d, e).
Then Median(a, c, c, d, e) = c.
Same Example
Ordered, most preferred choices: (a, c, c, d, e).
Then Median(a, c, c, d, e) = c.
Check:
Who prefers c to a: {1, 2, 4, 5}
Who prefers c to b: {1, 2, 4, 5}
Who prefers c to d: {2, 3, 4}
Who prefers c to e: {1, 2, 3, 4}
So c is indeed a Condorcet winner.
A2: Ordering
This required that the social choice rule output best
choices.
We could relax this and require only a partial

ordering.
For example, consider points x = (x1 , x2 ) ∈ R2 and

y = (y1 , y2 ) ∈ R2
I We could say x ≥ y if and only if x1 ≥ y1 and x2 ≥ y2 .
I We’d then be able to order x and y sometimes, but not
always.
I If x1 > y1 but x2 < y2 , we wouldn’t have x ≥ y or
y ≥ x.
Pareto Dominance
Pareto dominance creates a partial ordering.
We can let x y if and only if x i y for all i.
Provides a fairly compelling selection when

alternatives are ordered.
But is often silent. What do we do then?
We could complete the ordering by setting x ∼ y

when x and y are not ordered.
But then we have intransitivities again.

Example
Suppose there are two people with preferences:
a 1 b 1 c
b 2 c 2 a
Completing the Pareto ordering (P ) we get

c ∼P a and a ∼P b,
Example
a 1 b 1 c
b 2 c 2 a

c ∼P a and a ∼P b, which implies that:
c P a P b (as well as b P a P c)
Example
a 1 b 1 c
b 2 c 2 a

c ∼P a and a ∼P b, which implies that:
c P a P b (as well as b P a P c)
But b c, so we get an intransitivity.
A3: Pareto Principle
Perhaps hardest to give up.
But can some times be at odds with liberal

principles.
People should be allowed some control over their

own actions.
For example, whether you read a book or not.

The Impossibility of a Paretian Liberal
From Sen (1970).
Suppose N = {Lewd, Prude}.

And

Prude read Lady Chatterley’s Lover (x),

X = Lewd read Lady Chatterley’s Lover (y), .

Neither read the book (z).
Lewd has preferences x y z.

Prude has preferences z x y.
The Impossibility of a Paretian Liberal
Lewd should choose whether she reads the book or not.

Prude should choose whether she reads the book or not.
Then we should not choose x, and not choose z.
But y is Pareto dominated by x.
Sen called this the liberal paradox.
And formalized the idea with an impossibility result.
A4: IIA
Common axiom to give up.
Often see voting rules asking for more input, e.g. a

full preference ordering of alternatives.
We’ll consider two: Plurality rules and Boarda

count.
Plurality Rules
x y if and only if
|i : x i z for all z| ≥ |i : y i z for all z|

Plurality Rules
x y if and only if
So x y if and only if more people most prefer x than

most prefer y.
Are Condorcet cycles possible?

Plurality Rules
x y if and only if
So x y if and only if more people most prefer x than

most prefer y.
Are Condorcet cycles possible? No.

Plurality Rules
But there are other problems.
Suppose:
34% of people, x i y i z.
33% of people, y i z i x.
33% of people, z i y i x.
Plurality Rules
Suppose:
Plurality rule selects x, but y is a Condorcet winner.

Plurality Rules
Suppose:
Is there a good example of plurality rule causing trouble

in practice?
Plurality Rules
Suppose:
Is there a good example of plurality rule causing trouble

in practice? Who is Ralph Nader?
Borda Count
x y if and only if
X X
|z ∈ X : x i z| ≥ |z ∈ X : y i z|
i∈N i∈N
Borda Count
x y if and only if
X X
|z ∈ X : x i z| ≥ |z ∈ X : y i z|
i∈N i∈N
Each person gives each alternative a score.
Determined by how many things it is preferred to.
So if x is weakly preferred by i to 10 alternatives, i

gives x a score 10.
x y determined by summing these scores.

Borda Count
Why does this violate IIA?

Borda Count
Why does this violate IIA? Irrelevant alternatives

affect scores.
What problems might this create?

Borda Count
Suppose there are 303 alternatives but only x, y, z are
not Pareto dominated. These are ranked as follows,
34 people: R(x) = 1, R(y) = 102, R(z) = 103.
33 people: R(y) = 1, R(z) = 102, R(x) = 103.
33 people: R(z) = 1, R(y) = 102, R(x) = 103.
What would the Borda count select?

Borda Count
34 people: R(x) = 1, R(y) = 102, R(z) = 103.
33 people: R(y) = 1, R(z) = 102, R(x) = 103.
33 people: R(z) = 1, R(y) = 102, R(x) = 103.

Count for x: (34 × 302) + (66 × 200) = 23, 468.
Count for y: (33 × 302) + (67 × 201) = 23, 433.
Count for z:
(33 × 302) + (33 × 201) + (34 × 200) = 23, 399.
Borda Count
34 people: R(x) = 1, R(y) = 102, R(z) = 103.
33 people: R(y) = 1, R(z) = 102, R(x) = 103.
33 people: R(z) = 1, R(y) = 102, R(x) = 103.

Count for x: (34 × 302) + (66 × 200) = 23, 468.
Count for y: (33 × 302) + (67 × 201) = 23, 433.
Count for z:
(33 × 302) + (33 × 201) + (34 × 200) = 23, 399.
Borda count selects x, but y is a Condorcet winner.
Borda Count
34 people: R(x) = 1, R(y) = 102, R(z) = 103.
33 people: R(y) = 1, R(z) = 102, R(x) = 103.
33 people: R(z) = 1, R(y) = 102, R(x) = 103.

Count for x: (34 × 302) + (66 × 200) = 23, 468.
Count for y: (33 × 302) + (67 × 201) = 23, 433.
Count for z:
(33 × 302) + (33 × 201) + (34 × 200) = 23, 399.
Borda count selects x, but y is a Condorcet winner.
Would you always vote truthfully?
Summary
Might sometimes be able to restrict the domain and
resolve problems.
Summary
Might sometimes be able to restrict the domain and
resolve problems. But otherwise:
Ordering axiom is crucial for having a best
choice—hard to relax.
Completing the Pareto ordering creates problems.
Might be able to relax the Weak Pareto Principle
sometimes, but seems unlikely to help often.
Relaxing IIA, Plurality Rules and the Borda Count
didn’t always select Condorcet winners.
And relaxing Dictatorship is undesirable—we want
to aggregate preferences.
Outline

Two alternatives
Arrow’s Theorem: Formulation
Formulated in the space of ordinal preference
rankings.
Implicitly rules out interpersonal comparisons.
Grounded in prevailing philosophical thinking of the
time.
It is similar to restricting social choice rules to being
voting rules.
So perhaps more reasonable for voting problems
than social welfare.
Interpersonal Comparisons
The susceptibility of one mind may, for what we know,

be a thousand times greater than that of another. But
provided that the susceptibility was different in a like ratio
in all directions, we should never be able to discover the
difference. Every mind is thus inscrutable to every other
mind, and no common denominator of feeling seems to be
possible . . . the motive in one mind is weighed only against
other motives in the same mind, never against the motives
in other minds.
W.S. Jevons (1871, 1970), The Theory of Political Economy, cited
in Hammond (1991).
Sen formalized Arrow’s problem with a richer space
of inputs—individual welfare from different social
choices.
Can then formally restrict what information the

welfare function uses.
For example, Arrow’s set up is a special case in

which:
I There are no cardinal comparisons for an individual.
I There are no cardinal comparisons across individuals.
I There are no ordinal comparisons across individuals.
This approach helps formalize the restrictions

implicit in Arrow.
If we just permit cardinal comparison within
individuals. . .
. . . we still can’t break Arrow’s impossibility result.
However, with only ordinal interpersonal

comparisons we can.
There then exist social welfare functions satisfying

analogues of Arrow’s axioms.
Are interpersonal comparisons ever justified?

If based on subjective preferences, seems hard.
But sometimes, there might be an objective or

compelling ethical basis for the comparison.
Sen argued, for example, that:

Emperor Nero’s utility gained from burning Rome
was smaller than the sum-total of the utility loss of
all other Romans
Even Lionel Robins sees a role for interpersonal

comparisons in economics.
. . . I still think, when I make interpersonal comparisons
. . . that my judgments are more like judgments of value
than judgments of verifiable fact. Nevertheless, to those
of my friends who think differently, I would urge that, in
practice, our difference is not very important. They think
that propositions based upon the assumption of equality
are essentially part of economic science. I think that the
assumption of equality comes from outside, and that its
justification is more ethical than scientific. But we all
agree that it is fitting that such assumptions should be
made and their implications explored with the aid of the
economist’s technique.
Robbins, Lionel. ”Interpersonal Comparisons of Utility: A

Comment.” The Economic Journal (1938), cited in Hammond
(1991).
Social choice into Individual choice
One way of making interpersonal comparisons is behind
the “the veil of ignorance.”
Rawls (following Kant, following. . . )
Stripping away our “identities” we would make the
same choices.
So, in a thought exercise, do this.
Turns social choice into individual
choice—specifically, individual choice under
uncertainty.
Harsanyi shows that we then end up with a
utilitarian welfare function!
Conclusions
Thought systematically about social choice, aided

by the axiomatic method.
Formalization yields insights it would be hard to get

without the math.
But informal reasoning is crucial for guiding the

math and its interpretation.

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Part IIA, Paper 1

Game Theory, Welfare, and

About 16 lectures on game theory and applications.

Then 3-4 lectures on social choice and welfare.

2 Game Theory: Mixing Moves

3 Game Theory: Dynamic Games

4 Social Choice and Welfare

2 Game Theory: Mixing Moves

3 Game Theory: Dynamic Games

4 Social Choice and Welfare

Choices: Military actions, firm pricing, political

Choices: Military actions, firm pricing, political

Before 1950 when game theory took off, an acceptable

Before 1950 when game theory took off, an acceptable

Now, economists define their field as being about

Regarding the response to the virus:

Regarding the response to the virus:

Abstracts from the details, distilling some notion of

And Payoffs have the form: (1’s payoff, 2’s payoff)

A private house has been robbed.

Is this enough information to formulate the game?

A private house has been robbed.

Is this enough information to formulate the game? No.

Now can we formulate the game?

Now can we formulate the game? Yes, if we assume

What do we know about the relative magnitudes of

What do we know about the relative magnitudes of

2 Game Theory: Mixing Moves

3 Game Theory: Dynamic Games

4 Social Choice and Welfare

a∗i ∈ argmax ui (ai ).

But now i’s utility also depends on j’s actions.

Define an action profile in which all players are

ui (a) ≥ ui (a0i , a−i ) for all a0i ∈ Ai and for all i.

Players must be playing mutual best responses.

Find the Nash equilibria.

Find the Nash equilibria.

Find the Nash equilibria.

Find the Nash equilibria.

Bi (a−i ) = {ai ∈ Ai : ui (ai , a−i ) ≥ ui (a0i , a−i )

An action profile a∗ is a NE if and only if for all i ∈ N ,

2 Game Theory: Mixing Moves

3 Game Theory: Dynamic Games

4 Social Choice and Welfare

20, 21, 22, 23

20, 21, 22, 23

To alleviate congestion suppose we build the road

20, 21, 22, 23

To alleviate congestion suppose we build the road

What do we learn from this example?

Does it identify any further limitations of the Nash

Two firms i ∈ {1, 2}.

Simultaneously chooses a quantity to produce qi ≥ 0.

Each unit costs 0 to produce.

Market price depends on total production:

max πi (qi , qj ) subject to qi ≥ 0

Guess constraint does not bind, look for a qi that solves:

Problem is concave, so first order conditions characterize

Slack constraint assumption is good as long as qj < 1.

Suppose qj = 0. Then it is as if i is a monopolist.

Two players i ∈ {1, 2}.

max b1 (a1 + a2 ) − a1 subject to a1 ≥ 0.

Objective is concave, constraint is linear, so set up

max L(a1 ) = b1 (a1 + a2 ) − a1 + λ1 a1