BE 510 Business Economics 1

Dynamic games: Sequential moves

Prof. Dr. Henrik Orzen

Office hour: Tuesdays, 16:00-17:00 (by appointment)

Room 4.01 (Department of Economics, L7, 3-5)
E-Mail: henrik.orzen@uni-mannheim.de
Moving sequentially
Do you recognize this game?
Player 1
} Extensive form: An explicit description of the sequential
structure of a game (by drawing a game tree). X Y

} How many strategies does each player have?

Player 2 Player 2
} Player 1: Two — X versus Y.
} Player 2: Two — Left versus Right. Left Right Left Right

2, 1 0, 0 0, 0 1, 2
Moving sequentially
Do you recognize this game?
Player 1
} Extensive form: An explicit description of the sequential
structure of a game (by drawing a game tree). X Y

} How many strategies does each player have?

Player 2 Player 2
} Player 1: Two — X versus Y.
} Player 2: Four — (LeftX, LeftY) LeftX RightX LeftY RightY
(LeftX, RightY)
(RightX, LeftY) 2, 1 0, 0 0, 0 1, 2
(RightX, RightY).
} Remember: Strategy = Complete plan of action.
Moving sequentially
The sequential battle of the sexes in extensive form
Player 1
} Three Nash equilibria
X Y
} [1:X, 2:(LeftX, LeftY)]
} [1:X, 2:(LeftX, RightY)]
Player 2 Player 2
} [1:Y, 2:(RightX, RightY)]
} Are they all equally plausible? LeftX RightX LeftY RightY

2, 1 0, 0 0, 0 1, 2

The sequential battle of the sexes in normal form

Player 2
LXLY LXRY RXLY RXRY
X 2, 1 2, 1 0, 0 0, 0
Player 1
Y 0, 0 1, 2 0, 0 1, 2
 BE 510 Business Economics 1 • Game theory D • 3

Some definitions and concepts

The normal form representation of a game consists of…
} a (finite) set of 𝑛 players;
} an action set (possible strategies to choose from) for each player;
} a utility function for each player to define payoffs for every possible combination of strategies.
} Two-player games (𝑛 = 2): Can be practical to use a table to represent the game.

Player 2
A B C … X
a 𝑢!" , 𝑣!" 𝑢!# , 𝑣!# 𝑢!$ , 𝑣!$ … 𝑢!% , 𝑣!%

b 𝑢&" , 𝑣&" 𝑢&# , 𝑣&# 𝑢&$ , 𝑣&$ … 𝑢&% , 𝑣&%

Player 1
… … … … … …

y 𝑢'" , 𝑣'" 𝑢'# , 𝑣'# 𝑢'$ , 𝑣'$ … 𝑢'% , 𝑣'%

 BE 510 Business Economics 1 • Game theory D • 3

Some definitions and concepts

The extensive form representation of a game consists of…
} a (finite) set of 𝑛 players;
6, 3
} a set of decision nodes (one player per node) and a description of the HQ
actions available to the relevant player at each decision node; S 0, 4
t LQ
} a set of terminal nodes that assign payoffs to all players; rus
B T
} a sequential structure (a decision node plus an action taken at that node 2, 2
No trust
must lead either to another decision node or to a terminal node);
} a (single) root: A special decision node where the game starts.
 BE 510 Business Economics 1 • Game theory D • 3

Some definitions and concepts

Subgames
} Any game can also be part of a larger game.
} In that case it is called a subgame of that larger game.
7, 6, 3, 0
HQ
Singletons, information sets, and games of (im)perfect information S 2, 0, 4, 0
t LQ
} Several decision nodes of the same player may be connected by dashed lines to rus
B T
§” 4, 2, 2, 0
indicate that the player doesn’t know where exactly (s)he is currently located. No trust
A “!&
HQ 4, 6, 0, 6
} Decision nodes that are not connected by dashed lines are called singletons. T
“X t
/? us 1, 0, 0, 5
} The general term to refer to either a singleton or to a group of connected # Tr LQ
”
decision nodes is information set. B No tr
ust 2, 2, 0, 4

Thus, singletons are just a special type of information set.

} If a (sub)game consists only of singletons, it is a perfect-information game.
} If a (sub)game contains at least one non-singleton information set, it is an imperfect-information game.
 BE 510 Business Economics 1 • Game theory D • 3

Some definitions and concepts

More on subgames 4, 5,
3, 6, 3,
5, 80
GL HQ
7, 6, 3, 0
HQ
} The root of a (sub)game must be a singleton! 8,
1, 4,
0, 3,
6, 10 SGT S 2, 0, 4, 0
LQ
QR rruu t LQ
nszt us
} Any (sub)game must have a unique root. B S B Tr
5,
2,7,
2,3,
4,20 roo TSq 4, 2, 2, 0
No
Gr trust
brab fdfdr cohp §” No trust
} By definition: A game is always a subgame of itself. “S!c& A W
P n
A “!&
5,
4, 7,
6, 3,
0, 26 HQ
RR h§n HQ
” 4, 6, 0, 6
TGTTr T

Hdnks
Go to BK
} Therefore: Every game has at least one subgame: Itself! 1, 3,
4, 0, 2,
0, 15 rrfuua ”t “X t
sstt ?r#o /? us 1, 0, 0, 5
PA
LQ fd
/ # Tr LQ
} Other subgames beyond itself are called proper subgames. “PX ”
3,
8,
2,7,
1,
2,1,
1,
0,314 gssattaB T B No tr
ust 2, 2, 0, 4
Goohtstrnruu
NN
HQ
HQ
AP LQ
LQ
NT
Subgame-perfect Nash equilibrium B B
} Consider any game in extensive form.
0,
0,7,
5, 6,
6,3,
5,
5,200 8,
0, 4,
0, 3,
6, 10 0,5,
3,
4, 2,3,
3, 4,8
70
} Such a game may have several Nash equilibria.
4,
0,
0,3,
2,
2,2,
4,
4,100
} This is often the case.
} Can the number of solutions be reduced?
} Subgame perfection: Requires that the players play Nash equilibrium in every subgame.
} Find the SPE using backward induction.
 BE 510 Business Economics 1 • Game theory D • 3

SPE in the sequential battle-of-the-sexes game

Apply backward induction
} Begin at the end of the game tree.
Player 1
} Highlight those branches that are best responses for the player who
is moving at these last decision nodes. X Y

} Move up one step and repeat for the player who

controls these (second-to-last) decision nodes. Player 2 Player 2
} Repeat until you reach the root of the tree. LeftX RightX LeftY RightY

2, 1 0, 0 0, 0 1, 2

Player 2
LL LR RL RR
L 2, 1 2, 1 0, 0 0, 0
Reinhard Selten Player 1
R 0, 0 1, 2 0, 0 1, 2
1930 – 2016
 BE 510 Business Economics 1 • Preferences, utility and optimization • 12

Summary
Dynamic games
} Players move in sequence.
} Extensive-form description versus normal-form
description of a game.
Strategies in dynamic games
} Complete plans of action.
} Formed before the game is played.
} Combining different players’ plans determines
outcomes.
} Some such combinations are mutually best
Implausible Nash equilibria
} Strategies may contain non-sensible moves in
regions of the game tree that are expected to be
reached with probability zero.
} Such strategies may nevertheless form Nash
equilibria.
} Subgame-perfect Nash equilibrium (SPE):
} Requires optimal behavior and Nash equilibrium play in
ALL regions (subgames) of the game tree.
} Backward induction is an important method for finding
SPEs.

responses (Nash equilibria).