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two-person interactions.

• Initially, von Neumann and Morganstern

– Zero-sum games

• John Nash

– Nonzero-sum games

• Harsanyi, Selten

– Incomplete information

An example:

Big Monkey and Little Monkey

• Monkeys usually eat ground-level fruit

• Occasionally climb a tree to get a coconut

(1 per tree)

• A Coconut yields 10 Calories

• Big Monkey expends 2 Calories climbing

the tree.

• Little Monkey expends 0 Calories climbing

the tree.

An example:

Big Monkey and Little Monkey

• If BM climbs the tree

– BM gets 6 C, LM gets 4 C

– LM eats some before BM gets down

• If LM climbs the tree

– BM gets 9 C, LM gets 1 C

– BM eats almost all before LM gets down

• If both climb the tree

– BM gets 7 C, LM gets 3 C

– BM hogs coconut

• How should the monkeys each act so as to

maximize their own calorie gain?

An example:

Big Monkey and Little Monkey

• Assume BM decides first

– Two choices: wait or climb

• LM has four choices:

– Always wait, always climb, same as BM,

opposite of BM.

• These choices are called actions

– A sequence of actions is called a strategy

An example:

Big Monkey and Little Monkey

Big monkey w c

w c

Little monkey w c

What should Big Monkey do?

• If BM waits, LM will climb – BM gets 9

• If BM climbs, LM will wait – BM gets 4

• BM should wait.

• What about LM?

• Opposite of BM (even though we’ll never get to the right side

of the tree)

An example:

Big Monkey and Little Monkey

• These strategies (w and cw) are called best

responses.

– Given what the other guy is doing, this is the best thing

to do.

• A solution where everyone is playing a best

response is called a Nash equilibrium.

– No one can unilaterally change and improve things.

• This representation of a game is called extensive

form.

An example:

Big Monkey and Little Monkey

• What if the monkeys have to decide

simultaneously?

Big monkey w c

w c

Little monkey w c

Now Little Monkey has to choose before he sees Big Monkey move

Two Nash equilibria (c,w), (w,c)

Also a third Nash equilibrium: Big Monkey chooses between c & w

with probability 0.5 (mixed strategy)

An example:

Big Monkey and Little Monkey

• It can often be easier to analyze a game

through a different representation, called

normal form

Little Monkey

c v

c

v 9,1 0,0

Choosing Strategies

• In the simultaneous game, it’s harder to see

what each monkey should do

– Mixed strategy is optimal.

• Trick: How can a monkey maximize its

payoff, given that it knows the other

monkeys will play a Nash strategy?

• Oftentimes, other techniques can be used to

prune the number of possible actions.

Eliminating Dominated Strategies

• The first step is to eliminate actions that are

worse than another action, no matter what.

w c

Big monkey w c

c w c 9,1 4,4

w

Little monkey

We can see that Big

0,0 9,1 6-2,4 7-2,3 Monkey will always choose

w.

Little Monkey will Or this one So the tree reduces to:

Never choose this path. 9,1

Eliminating Dominated Strategies

• We can also use this technique in normal-

form games:

Column

a b

a 9,1 4,4

Row

b 5,3 0,0

Eliminating Dominated Strategies

• We can also use this technique in normal-

form games:

a b

a 9,1 4,4

b 5,3 0,0

Eliminating Dominated Strategies

• We can also use this technique in normal-

form games:

a b

a 9,1 4,4

b 5,3 0,0

(a,b) is the unique Nash equilibrium.

Prisoner’s Dilemma

• Each player can cooperate or defect

Column

cooperate defect

Row

defect 0,-10 -8,-8

Prisoner’s Dilemma

• Each player can cooperate or defect

Column

cooperate defect

Row

defect 0,-10 -8,-8

Prisoner’s Dilemma

• Each player can cooperate or defect

Column

cooperate defect

Row

defect 0,-10 -8,-8

Prisoner’s Dilemma

• Even though both players would be better

off cooperating, mutual defection is the

dominant strategy.

• What drives this?

– One-shot game

– Inability to trust your opponent

– Perfect rationality

Prisoner’s Dilemma

• Relevant to:

– Arms negotiations

– Online Payment

– Product descriptions

– Workplace relations

• How do players escape this dilemma?

– Play repeatedly

– Find a way to ‘guarantee’ cooperation

– Change payment structure

Tragedy of the Commons

• Game theory can be used to explain overuse of

shared resources.

• Extend the Prisoner’s Dilemma to more than two

players.

• A cow costs a dollars and can be grazed on

common land.

• The value of milk produced (f(c) ) depends on the

number of cows on the common land.

– Per cow: f(c) / c

Tragedy of the Commons

• To maximize total wealth of the entire

village: max f(c) – ac.

– Maximized when marginal product = a

– Adding another cow is exactly equal to the cost

of the cow.

• What if each villager gets to decide whether

to add a cow?

• Each villager will add a cow as long as the

cost of adding that cow to that villager is

outweighed by the gain in milk.

Tragedy of the Commons

• When a villager adds a cow:

– Output goes from f(c) /c to f(c+1) / (c+1)

– Cost is a

– Notice: change in output to each farmer is less than

global change in output.

• Each villager will add cows until output- cost = 0.

• Problem: each villager is making a local decision

(will I gain by adding cows), but creating a net

global effect (everyone suffers)

Tragedy of the Commons

• Problem: cost of maintenance is externalized

– Farmers don’t adequately pay for their impact.

– Resources are overused due to inaccurate estimates of

cost.

• Relevant to:

– IT budgeting

– Bandwidth and resource usage, spam

– Shared communication channels

– Environmental laws, overfishing, whaling, pollution,

etc.

Avoiding Tragedy of the Commons

• Private ownership

– Prevents TOC, but may have other negative effects.

• Social rules/norms, external control

– Nice if they can be enforced.

• Taxation

– Try to internalize costs; accounting system needed.

• Solutions require changing the rules of the game

– Change individual payoffs

– Mechanism design

Coming next time

• How to select an optimal strategy

• How to deal with incomplete information

• How to handle multi-stage games

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