8.2 - Noncooperative Game Theory

Outline of the chapter
Introduction to Noncooperative Game Theory

Simultaneous-move games
Dynamic games
Complete information
Incomplete information
Incomplete/imperfect information
Repeated games
In a game of incomplete information, the players

lack relevant information on some other players
relevant characteristics, or on payoffs that players
receive
Example: auction. Bidders do not know the other
bidders valuation for the good auctioned
A players type is the private information he has
available before the game begins: in an auction, a
players type is his individual valuation of the good
A Bayesian game is
I, S
I
i i 1
, u , , F
I
i i 1
I
i i 1
i i
Player is type is
where (1 ,..., I ) ~ F( 1 ,..., I ), is common

knowledge
Player is payoff is u i ( s i , s i , i )
We analyze games of incomplete information by

transforming them into games of imperfect
information
Nature chooses the realization of players types: it is
supposed to be just another player which moves
first
Each player defines his strategy for every possible
realization of his own type
Example: Prisoners dilemma with two types

Player 1 has only one type (normal)
Player 2 has two types: normal and abnormal. If
abnormal, he pays a penalty of 6 years if confessing
Nature chooses player 2s type to be normal with
probability p [ 0 ,1]
The games extensive form is

Nature
p
1-p
P1
C
DC
P2
C
5
DC
P2
DC
1
10
C
10
DC
0
C
5
11
DC
1
10
C
10
DC
0
If player 2s type was normal, player 1 would choose

Confess
However, is player 2s type was abnormal, player 1
would choose Dont Confess
If player 1 plays Confess, his expected payoff is: 5p-(1-p)
If player 1 plays Dont Confess, his expected
payoff is: -10p
Thus, if p>(1/6), player 1 plays Confess
7
s1 (.),..., s I (.) is a Bayesian Nash equilibrium iff for

every player i, for every type i occurring with
positive probability,
Ei ui (si (i ), si (i ),i ) | i Ei ui (s'i , si (i ),i ) | i
for every type, player, and feasible strategy

Each player maximizes his expected utility
contingent on his type and taking the other players
type-contingent strategies as given
In the previous example, if p=0.5, the Bayesian

Nash equilibrium is (Confess; Confess if normal,
Dont confess if abnormal)
Notice that player 2s strategy is contingent on its
type. Player 1s strategy takes into account the
distribution of player 2s types

Dynamic games
Repeated games
10
Dynamic games
Some games only have one subgame:

n1
L1
1 2

2 0
0
3
Player 1
R1
M1
n2
n3
L2
3

2
0

R2
L2
R2
n4
n5
Player 2
Player 3
L3
R3
L3
R3
0

1
3

1

4
0

0

1
1

0

1
0

1

0
0

11
Dynamic games
Players beliefs are the probabilities that players

assign to being at different nodes within the same
information set
The construction of beliefs may be arbitrary.
However, we will focus on beliefs that are consistent
with players actual strategies
12
Dynamic games
In our example, player 3 has a dominant strategy,

L3
But then, player 2 has a dominant strategy, L2
Therefore, player 1s optimal strategy is M1
Then, the beliefs that are consistent with players
strategies are:
Pr(n2|H2)=1
Pr(n4|H3)=p, with p [0,1]
13
Dynamic games
A strategy profile and a system of beliefs is a

Weak Perfect Bayesian Equilibrium (WPBE) if:
is sequentially rational given

is derived from the strategy profile using Bayes rule for
any information set H reached with positive probability, i.e.
Pr(x | )
(x)
,
Pr(H | )
x H
s.t.
Pr(H | ) 0
14
Dynamic games
Notice that WPBE is silent with respect to beliefs

within information sets that are not reached in
equilibrium
In our previous example, player 3 could assing any
probability to node n4, since this information set was
not reached in equilibrium
15
Dynamic games
A Sequential Equilibrium is a WPBE that is also a

SPE
For instance, the following game has a WPBE, but
no SPE, since the WPBE strategy does not induce
an equilibrium in the post-entry subgame
16
Dynamic games
Example:
Entrant
Out
In
Incumbent
E 0

I 2
Entrant
3

1
17
Dynamic games
A WPBE is (Out, Accommodate; Fight), with the

incumbent believing that the entrant will fight after
entry
However, the SPE after entry is both players
accommodating, thus in some sense, the WPBE is
based on an irrational belief on the incumbents side
The only sequential equilibrium is (In,
Accommodate; Accommodate)
18

Dynamic games
Repeated games
19
Repeated games
I players repeatedly play the stage game

I
I
N I, Si i1 , ui i1 at t=1,2,,T. Payoffs are
discounted at a rate 1
Players observe all previous plays prior to playing
the stage game. This constitutes the history of the
game up to period t
Ht (S1,...,St ),
with
Sj (S1j ,...,SIj )
20
Repeated games
A pure strategy is therefore a function of the history

of the game:
s i s it (H
t 1
) t 1
i(s i ) max ui(s i , s i )

Let u
s S
Obviously, a Nash Equilibrium of the stage game is
also an equilibrium of the repeated game
The question is whether there are other equilibria in
the repeated game
i
21
Repeated games
For example, in the following game:

Player 2
Coop NC
Player 1
Coop 3,3
-1,4
NC
0,0
4,-1
the NE of the stage game is NC, NC

If the game is played a finite number of times, the
SPE is (NC,NC) every period
22
Repeated games
If the game is played an infinite number of times, a

SPE is again (NC,NC) every period
However, both players playing the following Nashreversion strategy is also an equilibrium:
t 1
((C, C),(C, C),...)

C
if
t
0
or
if
t
0
and
H
t 1
sit(H )
DC otherwise
23
Repeated games
Why is this an equilibrium? Every period, player 1

faces the following trade-off:
If it continues with cooperation, it will obtain 3 every period

forever
If it deviates, it will obtain 4 one period and 0 forever
starting the period after deviation
Thus cooperate as long as

1
1
43

1
4
24
Repeated games
The Folk Theorem says that any feasible

individually rational payoffs can be supported as the
avearage payoffs in an SPE, for sufficiently high
realizations of the discount factor
25

8.2 - Noncooperative Game Theory

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Outline of the chapter

Introduction to Noncooperative Game Theory

In a game of incomplete information, the players

where (1 ,..., I ) ~ F( 1 ,..., I ), is common

We analyze games of incomplete information by

Example: Prisoners dilemma with two types

The games extensive form is

If player 2s type was normal, player 1 would choose

s1 (.),..., s I (.) is a Bayesian Nash equilibrium iff for

Ei ui (si (i ), si (i ),i ) | i Ei ui (s'i , si (i ),i ) | i

for every type, player, and feasible strategy

In the previous example, if p=0.5, the Bayesian

Outline of the chapter

Introduction to Noncooperative Game Theory

Some games only have one subgame:

Players beliefs are the probabilities that players

In our example, player 3 has a dominant strategy,

A strategy profile and a system of beliefs is a

is sequentially rational given

any information set H reached with positive probability, i.e.

Notice that WPBE is silent with respect to beliefs

A Sequential Equilibrium is a WPBE that is also a

A WPBE is (Out, Accommodate; Fight), with the

Outline of the chapter

Introduction to Noncooperative Game Theory

I players repeatedly play the stage game

A pure strategy is therefore a function of the history

i(s i ) max ui(s i , s i )

For example, in the following game:

the NE of the stage game is NC, NC

If the game is played an infinite number of times, a

((C, C),(C, C),...)

Why is this an equilibrium? Every period, player 1

If it continues with cooperation, it will obtain 3 every period

Thus cooperate as long as

The Folk Theorem says that any feasible

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