Introduction to Game Theory

Gabriel Carroll, Econ 180, Fall 2014

September 22, 2014

Logistics
Go through syllabus overview, emphasizing:
mathematical background (no econ needed);
differences from other game theory classes;
grading policy, including midterm date (Mon Oct 27) and final exam (Fri Dec
12, 8:30 11:30 AM)
Textbooks
Tadelis is the most advanced undergrad book, its good but not deep enough
Fudenberg-Tirole is the standard grad book, not ideal for a first course
So the main source is the lectures; Ill post outlines and Xin will write more
detailed notes as class goes along
Will play a few games in class, with Xin administering
Ill try to learn who everyone is, but it will take a while; you are encouraged to come
to office hours

What are games?

Classic kind of problem in economic theory: decision problem one player makes
a decision

 Example: a monopolist setting price p [0, ) to maximize profit (p c)D(p),

where cost c > 0 is constant and D(p) is some continuous, decreasing, positivevalued function
Game theory studies situations where two or more decision-makers interact, and
each ones preference may depend on what the others are doing
Example: two firms in Bertrand competition. Each sets a price p1 , p2 , and
all customers buy from the lowest-price firm, or they split evenly if prices are
equal. So firm 1s profits are (p1 c)D(p1 ) if p1 < p2 , (p1 c)D(p1 )/2 if p1 = p2 ,
and 0 if p1 > p2 , and likewise for firm 2. Particular choices of c and D(p) (say,
c = 1 and D(p) = 1/(1 + p)) make this into a specific game
Firm 1 wants to just undercut whatever it thinks 2 will charge (unless 2 will
charge c)
Many more examples of situations modeled as games....
Industrial organization: firms deciding what products to develop, how much
to advertise
Labor economics: workers deciding how hard to compete for a promotion;
workers getting education to signal their ability to employers
Development economics: farmers deciding whether to experiment with a new
crop, or wait for their neighbors to experiment; deciding whether to share food
with neighbor in a famine year, hoping the neighbor can pay back later
Macroeconomics: firms setting prices based on expectations of future inflation
Finance: traders deciding how much of various assets to buy and sell, depending
on their private knowledge
Political science: legislators bargaining over how to divide a budget; countries
deciding how much to spend fighting a war; candidates choosing their platforms
to try to get elected
Urban planning: commuters deciding which road (or train, boat...) to take
Computer science: routers deciding where to send network traffic; hackers
looking for security holes
Evolutionary biology: animals level of aggression / territoriality
2

Formal definition and examples

Ingredients in a (normal-form / strategic-form) game G = (N, A, u):
N = {1, . . . , n} set of players
A = A1 An where Ai is is actions (or strategies)
u = (u1 , . . . , un ), ui : A R set of payoff functions the thing each player
wants to maximize
Notation a for action profile, ai for actions of opponents, Ai for set of action
profiles of opponents, (ai , ai )
Examples describe all the ingredients
Bertrand competition, as before
Coordination game:
A

A 1, 1 0, 0
B 0, 0 1, 1
(explain matrix notation for finite two-player games)
Anti-coordination or matching pennies game (applications could include generals choosing where to attack and defend, or two firms, with one stronger than
the other, deciding what products to market):
H

H 1, 1 1, 1
T

1, 1 1, 1

Prisoners dilemma
C

C 2, 2 0, 3
D 3, 0 1, 1
Applications include any kind of simultaneous favor exchange, e.g. offering to
do an errand for a friend thats convenient for you; or not littering in the park.
Usually associated with the silly prisoner story

Dominance
We want to predict how people will behave in games
One prediction: people wont do something if theres something else obviously better. Specifically, say action ai strictly dominates ai if ui (ai , ai ) > ui (ai , ai ) for
every ai Ai .
We usually are comfortable predicting that people wont play something strictly
dominated
Example: in prisoners dilemma, C strictly dominates D. So we predict (D, D) as
the unique outcome. Note that both players nonetheless prefer (C, C).
If players can foresee others rationality, we can sometimes predict more. Example:
the follow your crush to lunch game. 1 = you, 2 = your crush, A and B are places
to eat lunch. You like A better, but mostly just want to be near your crush; crush
likes B better and doesnt care about you.
A

A 4, 0 1, 1
B 0, 0 3, 1
Iteratively deleting dominated strategies gets us to (B, B).
Will study this process in more detail next week....

Nash equilibrium
In many games, nothing is dominated. But would still like to make some kind of
prediction.
Some predictions better than others. For example, in coordination game, if we
confidently predicted (A, B), we shouldnt be so confident, since either player would
like to change.
N ash equilibrium: a strategy profile a A such that ui (a) ui (ai , ai ) for all i and
all ai Ai .

 This is the most fundamental concept in game theory

A consistent prediction for what players will do
Solve some of the earlier examples....
Bertrand competition: only Nash equilibrium is (c, c). First, check this is an
NE. Then, show there are no others. (Sketch: WLOG can focus on profiles
with p1 p2 ; if p1 < c then 1 would rather charge more, if p1 > c then 2 would
rather undercut 1, and if p1 = c and p2 > c then 1 would rather charge more.
So only (c, c) can be NE)
Prisoners dilemma: only (D, D)
Coordination game: (A, A) and (B, B)
Matching pennies: none!
As we can see, games can have multiple NE, or none
In the matching pennies game, there is nonetheless an intuitive prediction: wed
expect to see each player choosing H and T each half the time.
There is an extension of NE that gives us this prediction, but first we need a little
detour....