Game Theory

Vivekananda Mukherjee
Department of Economics and Finance
BITS-Pilani, Hyderabad Campus
Lecture 6
Summary
• Iterated elimination of strictly dominated strategy solution concept
……Order of elimination does not matter in elimination of strictly
dominated strategies
……order of elimination matters in the case elimination of weakly
dominated strategies

In the normal form game , let and be the feasible strategies for player . Strategy is
weakly dominated by strategy if for each feasible combination of the other players’
strategies, ’s payoff from playing is strictly less than ’s payoff from playing :

for each that can be constructed from the other players’ strategy spaces .
Summary (contd.)

A weakly dominated action that is not strictly dominated, unlike a strictly

dominated action, is not an unambiguously poor choice

Player 2
L C R
T 2,2 2,1 1,0
Player 1
B 2,1 2,2 0,2
Iterated Elimination of Strictly Dominated Strategies
Limitations
1. Strong informational requirement: Rationality is common knowledge
2. Cannot be applied to a large class of games: no prediction can be generated in
such games by application of the solution concept

Player 2
L C R
T 0, 4 4, 0 5, 3
Player 1 M 4, 0 0, 4 5, 3
B 3, 5 3, 5 6, 6
Is rationality a common knowledge?
Test (Thaler (1997)): How a game is played by players in a situation similar to
Keynes’ beauty contest example.

J. M. Keynes likened investment in financial markets to a newspaper competition in

which readers have to choose the “prettiest face”; the reader who chose the most
frequently chosen face win.

Predicting behavior of the

average investor Predicting
average choice of newspaper
readers
Thaler’s guessing game
Readers pick a number (an integer) between 0 and 100.

The winner is the contestant with the number closest to 2/3 of the average of all
numbers entered in the contest.

Which number would you pick?

In Thaler’s Financial Times experiment, the newspaper received more than a

thousand entries.
The number 33 was the most frequently picked number, followed by the number
22. Some entries were between 67 and 100.
Do you think that the players are rational and rationality is a common knowledge?
Nash Equilibrium

A solution concept that produces much tighter predictions in a very broad class of
games.
…….a stronger solution concept than IESDS in the sense that the players’
strategies in a Nash equilibrium always survive iterated elimination of strictly
dominated strategies, but the converse is not true.
Nash Equilibrium
Motivation

If game theory is to provide a unique prediction to a game-theoretic problem then

the solution must be a Nash equilibrium
……in order the prediction to be correct, it is necessary that each player be
willing to choose the strategy predicted by the theory
…….thus each player’s predicted strategy must be that player’s best response
to the predicted strategies of the other players
……such a prediction could be called strategically stable or self-enforcing,
because no single player wants to deviate from his or her predicted strategy.
Nash Equilibrium
Definition

In the -player normal form game , the strategies are a Nash equilibrium if, for each
player , is (at least tied for) player ’s best response to the strategies specified for
the other players, :

for every feasible strategy in ; that is solves

.
Nash equilibrium (contd.)

Suppose game theory offers the strategies as the solution to the normal-form
game .
……saying that is not a Nash equilibrium of is equivalent to saying that
there exists some player such that is not a best response to . That is there exists
some in such that

…..thus if is not a Nash equilibrium of , then at least one player will have
an incentive to deviate from the theory’s prediction, so the theory will be
falsified by the actual play of the game.