Game Theory and the Design of

Institutions
Seminar Week 8 – Dynamic Bayesian games, WSE
Exercise 1 – Would You Like Beer or Quiche?
• A newcomer walks into a bar
• With probability 90% he is strong
• with probability 10% he is weak

• Once he is in the bar, he may order either beer or quiche

• If he is strong he gets utility 3 from beer and 2 from quiche
• If he is weak he gets utility 0 from beer and 3 from quiche.

• In the bar is a redneck

• The redneck cannot tell whether or not the newcomer is

weak or strong but he can see whether the newcomer
orders beer or quiche
 3

Exercise 1 – Would You Like Beer or Quiche?

• After this observation, the redneck must decide whether
or not to start a fight
• If he fights the weak he gets a utility of 3
• If he fights the strong he gets a utility of –1
• If he doesn’t fight he gets a utility of 0
• The newcomer prefers not to fight: if there is a fight he gets a
penalty of 2

 Draw the extensive form of the game

Exercise 1 – Would You Like Beer or Quiche?

• This game is dynamic, perfect and incomplete

Exercise 1 – Would You Like Beer or Quiche?
• Compute pure WSE without drawing
the normal form. Are they pooling or
separating?

• How to find WSE directly from the extended form?

• Calculate expected utilities of player 2 as a function of beliefs b
and q
• b a belief on the probability that if player 1 orders beer he is strong
• q a belief on the probability that if player 1 orders quiche he is strong
• Find which strategy is optimal for player 2 given his beliefs
• Find if player 1 BR to player 2 strategy fits with player 2 beliefs
Exercise 1 – Would You Like Beer or Quiche?
• For player 1playing B:
• 𝑈2 𝐹, 𝐵 = 𝑏 ∙ −1 + 1 − 𝑏 ∙ 3 = 3 − 4𝑏
• 𝑈2 𝑁, 𝐵 = 𝑏 ∙ 0 + (1 − 𝑏) ∙ 0 = 0
3
• If b ≤ then player 2 plays F after B
4
3
• If b ≥ 4 then player 2 plays N after B

• For player 1playing Q:

• 𝑈2 𝐹, 𝑄 = 𝑞 ∙ −1 + 1 − 𝑞 ∙ 3 = 3 − 4𝑏
• 𝑈2 𝑁, 𝑄 = 𝑞 ∙ 0 + (1 − 𝑞) ∙ 0 = 0
3
• If q ≤ then player 2 plays F after Q 3 3
4
q≤ q≥
3 4 4
• If q ≥ 4 then player 2 plays N after Q
3 F(B)F( FN
b≤
4
Q)
• Given player 2 beliefs, his strategies are: b≥
3 NF NN
4
Exercise 1 – Would You Like Beer or Quiche?
• If player 2’s strategy is FF
• Player 1 BR is (B if strong , Q if weak)
• That is, 𝑏 = 1 and q = 0
• In this case player 2 better play NF
• This then can not be a WSE

• If player 2’s strategy is NF

• Player 1 BR is (B if strong , Q if weak)
• That is, 𝑏 = 1 and q = 0
• Player 2 beliefs match his strategy
• (BQ,NF) is a separating WSE with 𝑏 = 1 and q = 0
33 33
qq ≤
≤ qq ≥
≥
44 44
• Payoffs are: 33 F(B)F(
F(B)F( FN
FN
bb ≤
≤
• Pr 𝑆 ∙ 3,0 + Pr 𝑊 ∙ 1,3 = 44
Q)
Q)
= 0.9 ∙ 3,0 + 0.1 ∙ 1,3 = (2.8,0.3) 33 NF
NF NN
NN
bb ≥
≥
44
Exercise 1 – Would You Like Beer or Quiche?
• If player 2’s strategy is NN
• Player 1 BR is (B if strong , Q if weak)
• That is, 𝑏 = 1 and q = 0
• In this case player 2 better play NF
• This then can not be a WSE

• If player 2’s strategy is FN

• Player 1 BR is (Q if strong , Q if weak)
• That is, 𝑏 is off-equilibrium and q = 0.9
• Player 2 beliefs match his strategy
3
• (QQ,FN) is a pooling WSE with 𝑏 ≤ and q = 0.9
4
33 33
qq ≤
≤ qq ≥
≥
• Payoffs are: 44 44
33
• Pr 𝑆 ∙ 2,0 + Pr 𝑊 ∙ 3,0 = bb ≤
≤ F(B)F( FN
44
= 0.9 ∙ 2,0 + 0.1 ∙ 3,0 = (2.1,0) Q)
33 NF NN
bb ≥
≥
44
Exercise 2 - Not a tree but forest
 Classify this game
• Dynamic, imperfect and
complete

• How many subgames?

• 4 subgames

 What is the most appropriate solution concept for

this type of game?
• SPNE (though WSE and NE can be used)
 Exercise 2 - Not a tree but forest
 Find pure NE (also possible to do SPNE)
• Note: Due to space limit the strategies of
player 1 are the top ones (payoffs are
specified as usual)
• Find BR for player 1
• Find BR for player 2
• NE are (MTA,DX) and (MTB,DX)

LHA LHB LTA LTB MHA MHB MTA MTB RHA RHB RTA RTB
UX 4,0 4,0 4,0 4,0 5,0 5,0 5,0 5,0 1,5 1,5 1,5 1,5
UY 4,0 4,0 4,0 4,0 5,0 5,0 5,0 5,0 1,3 6,4 1,3 6,4
DX 1,1 1,1 1,1 1,1 1,7 1,7 2,1 2,1 1,5 1,5 1,5 1,5
DY 1,1 1,1 1,1 1,1 1,7 1,7 2,1 2,1 1,3 6,4 1,3 6,4
Exercise 2 - Not a tree but forest
• What is the SPNE?
• (MTB, DX)

• Assign beliefs on the game tree above. Compute

beliefs that support the above equilibria as WSE
• Assign beliefs 𝑝 = Pr⁡(𝐿) and 1 − 𝑝 = Pr⁡(𝑀)
Exercise 2 - Not a tree but forest
• Any belief p that leads player 2 to play D is consistent
with this SPNE as a WSE
• Player 2’s payoffs given belief p are:
• 𝑈2 𝐷 = 𝑝 ⋅ 1 + 1 − 𝑝 ⋅ 1 = 1
• 𝑈2 𝑈 = 𝑝 ⋅ 0 + 1 − 𝑝 ⋅ 0 = 0

• For any belief p, 𝑈2 𝐷 > 𝑈2 𝑈

• Player 1 plays M in this SPNE

• From Bayes’ rule, we find that p = 0
• The WSE is (MTB,DX) with p = 0
Exercise 3 -Never say never enter again
• Find all WSE without searching for NE
Exercise 3 -Never say never enter again
• This is a dynamic, imperfect and complete game
• Nonetheless, we can use WSE

• We start by assigning beliefs p and 1-p

• Lets write player 2 expected payoffs

• 𝑈2 𝑙 = 𝑝 ⋅ 4 + 1 − 𝑝 ⋅ 4 = 4
• 𝑈2 𝑟 = 𝑝 ⋅ 3 + 1 − 𝑝 ⋅ 5 = 5 − 2𝑝

1
• If 𝑝 >then 𝑈2 𝑙 > 𝑈2 𝑟 ⁡⁡⁡ →⁡⁡⁡player 1 plays M → from
2
Bayes rule we find that 𝑝 = 0⁡⁡ →⁡⁡not a WSE
Exercise 3 -Never say never enter again
1
• If 𝑝 <then 𝑈2 𝑙 < 𝑈2 𝑟 ⁡⁡⁡ →⁡⁡⁡player 1 plays L → from
2
Bayes rule we find that 𝑝 = 1⁡⁡ →⁡⁡not a WSE

1
• If 𝑝 = then 𝑈2 𝑙 = 𝑈2 𝑟 ⁡⁡⁡ →⁡⁡⁡player 2 is indifferent
2
• Player 2 plays 𝑙 with probability q and 𝑟 with probability 1-q

• Player 1 payoffs are then:

• 𝑈1 𝐿 = 𝑞 ⋅ 0 + 1 − 𝑞 ⋅ 5 = 5 − 5𝑞
• 𝑈1 𝑀 = 𝑞 ⋅ 4 + 1 − 𝑞 ⋅ 0 = 4𝑞
• 𝑈1 𝑅 =1
Exercise 3 -Never say never enter again
• Note that R is dominated by an equal mixing of L and M
• 0.5 ⋅ 5 − 5𝑞 + 0.5 ⋅ 4𝑞 = 2.5 − 0.5𝑞 > 1
• That is (0.5,0.5,0) strictly dominates R
• Actually, for any mixing q, player 1 BR is L or M – never R

• In order for the belief p = 0.5 to be consistent it must be that

player 1 is indifferent between L and M
5
• 𝑈1 𝐿 = 𝑈1 𝑀 ⁡⁡ → ⁡⁡⁡5 − 5𝑞 = 4𝑞⁡⁡ → ⁡⁡𝑞 =
9

• The WSE is that:

1 1 5 4 1
• , ,0 , , ⁡𝑤𝑖𝑡ℎ⁡𝑝 =
2 2 9 9 2
20
• The payoff is ,4
9
Exercise 4 – Three Type Signaling
• Find all pure BNE of this game

• This game is dynamic, perfect and incomplete

Exercise 4 – Three Type Signaling
• How many strategies are there ?
• Player 1 has 8 strategies
• Player 2 has 4 strategies

• Construct the game in normal form to

find the BNE
• This requires a 8x4 table of strategies

• This can be made simpler if we notice that for player 1 of type

𝑡1 it is a dominant strategy to play L
• LLL strictly dominates RLL
• LRL strictly dominates RRL
• LLR strictly dominates RLR
• LRR strictly dominates RRR
Exercise 4 – Three Type Signaling
• The (reduced form) normal form is:
u(L)u(R) ud du dd
LLL 4,3 4,3 1,0 1,0
LLR 3,2 5,3 1,0 3,1
LRL 3,3 3,2 2,1 2,0
LRR 2,2 4,2 2,1 4,1

• Recap: how to calculate payoff of (LLR , ud)

• if 𝑡1 : player 1 plays L, player 2 plays u → ⁡ 3⁡, 3
• if 𝑡2 : player 1 plays L, player 2 plays u → ⁡ 6⁡, 3
• If 𝑡3 : player 1 plays R, player 2 plays d → ⁡ 6⁡, 3

𝑈 𝐿𝐿𝑅, 𝑢𝑑 = Pr⁡(𝑡1 ) ∙ 3⁡, 3 + Pr⁡(𝑡2 ) ∙ (6⁡, 3) + Pr⁡(𝑡2 ) ∙ (6⁡, 3)

1 1 1
= ∙ 3⁡, 3 + ∙ 6⁡, 3 + ∙ 6⁡, 3 = (5,3)
3 3 3
Exercise 4 – Three Type Signaling
u(L)u(R) ud du dd
LLL 4,3 4,3 1,0 1,0
LLR 3,2 5,3 1,0 3,1
LRL 3,3 3,2 2,1 2,0
LRR 2,2 4,2 2,1 4,1

• Note: The normal form can also be deduced from a

bayesian game representation
• To find the BNE:
• Find best responses
• The NE are (LLL,uu) and (LLR,ud)
Exercise 4 – Three Type Signaling
 Find all pure WSE of this game.
Are they pooling or separating?

• Should we check all possible strategies

for WSE ?
• NO, the WSE is a subset of the BNE

• A WSE is a strategy profile and a system of beliefs (𝜎, 𝜇)

that satisfies:
• The strategy profile 𝜎 is sequentially rational given beliefs 𝜇
• The system of beliefs 𝜇 is consistent with strategy profile 𝜎
• 𝐸 𝑢𝑖 𝐻𝑖 , 𝜇, 𝜎𝑖 , 𝜎−𝑖 ≥ 𝐸 𝑢𝑖 𝐻𝑖 , 𝜇, 𝜎𝑖 , 𝜎−𝑖 ∀𝑖, 𝐻𝑖
Exercise 4 – Three Type Signaling
• How to find the WSE?
• Check for each BNE whether it is a WSE
• Use Bayes’ rule where possible to find the probabilities of player 2
reaching specific nodes given player 1 strategy.
• These probabilities are player 2 beliefs in equilibrium
• If an I-set is off-equilibrium then Bayes rule can not be used
• Find if player 2 strategy fits with his beliefs
• In an off-equilibrium case, find the beliefs which justify player 2 BNE
strategy
• If Beliefs and strategies match, this is an WSE
Exercise 4 – Three Type Signaling
• Lets first examine the BNE (LLL,uu)

• What is the probability that player 2 is in

nodes 𝑙1 and 𝑙2 in case player 1 plays L?

𝑃𝑟 𝑙 𝜎 𝑃𝑟 𝑙 𝜎
Bayes rule: 𝑃𝑟 𝑙 𝐻𝑖 , 𝜎 = =
ℎ∈𝐻 𝑃𝑟 ℎ 𝜎
𝑖
𝑃𝑟 𝐻𝑖 𝜎

1
∙1 1
𝑙1 = 𝑙2 = 3 =
1 1 1
∙1+ ∙1+ ∙1 3
3 3 3
Exercise 4 – Three Type Signaling
1
• Given the belief 𝜇 that 𝑙1 = 𝑙2 = , is
3
player 2 strategy to play u after L
sequentially rational?

• Lets check expected payoffs from

playing u and d after player 1 plays L:
1 1 1
• 𝑈2 𝑢 = ∙3+ ∙3+ ∙3 =3
3 3 3
1 1 1
• 𝑈2 𝑑 = ∙0+ ∙0+ ∙3 =0
3 3 3

• Since 𝑈2 𝑢 > 𝑈2 𝑑 , the strategy of player 2 is consistent

with the beliefs
Exercise 4 – Three Type Signaling
• What beliefs sustain player 2 strategy to play u
after player 1 plays R?
• Problem: We cannot use Bayes rule since R is
an off-equilibrium I-set
• All beliefs are possible then. We have to find
which ones satisfy player 2 strategy to play u
• Lets check expected payoffs:
• 𝑈2 𝑢 = 𝑟1 ∙ 3 + 𝑟2 ∙ 3 + (1 − 𝑟1 − 𝑟2 ) ∙ 0 = 3(𝑟1 + 𝑟2 )
• 𝑈2 𝑑 = 𝑟1 ∙ 0 + 𝑟2 ∙ 0 + 1 − 𝑟1 − 𝑟2 ∙ 3 = 3 − 3(𝑟1 + 𝑟2 )
• The condition for 𝑈2 𝑢 ≥ 𝑈2 𝑑 is:
3 𝑟1 + 𝑟2 ≥ 3 − 3 𝑟1 + 𝑟2
1
→ 𝑟1 + 𝑟2 ≥
2
1 1
• Strategy (LLL,uu) with beliefs 𝑙1 = 𝑙2 = and 𝑟1 + 𝑟2 ≥ is a WSE
3 2
Exercise 4 – Three Type Signaling
• Lets examine now the BNE (LLR,ud)

• What is the probability that player 2 is in

nodes 𝑙1 and 𝑙2 in case player 1 plays L?
1
3
∙1 1
𝑙1 = 𝑙2 = 1 1 1 =
∙1+ ∙1+ ∙0 2
3 3 3
• What is the probability that player 2 is in nodes 𝑟1 and 𝑟2 in
case player 1 plays R?
1
∙0
3
𝑟1 = 𝑟2 = 1 1 1 =0
3
∙0+3
∙0+3
∙1
Exercise 4 – Three Type Signaling
• We can now verify that the strategies of
player 2 match these beliefs

• Strategy (LLR,ud) with beliefs

1
𝑙1 = 𝑙2 = and 𝑟1 = 𝑟2 = 0 is a WSE
2

• What type of WSE are the two equilibria we found?

• (LLL,uu) is a pooling equilibrium
• (LLR,ud) is a (semi)separating equilibrium.
Exercise 5 - Think about this
• Assume a dynamic, perfect and complete game with 2
players
• Player 1 plays first
• His possible actions are A, B, C and D
• Then player 2 plays.
• He can play L, M or R
• Player 1 plays again
• He can now play u or d

• How many strategies does each player have in this

game?
Exercise 5 - Think about this
• Player 1: 4 ⋅ 212 = 16384
• Player 2: 34 = 81