ECO290E Game Theory

Lecture 2: Static Games and Nash Equilibrium

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Review of Lecture 1
Game Theory

studies strategically inter-dependent situations.

provides us tools for analyzing most of problems in social
science.

employs Nash equilibrium as a solution concept.

made a revolution in Economics.

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Two Frameworks of Game Theory

Non-cooperative Game Theory

examine individual decision making in strategic settings.

assume a person decides her action on her own.

does NOT rule out cooperative behaviors.

Cooperative Game Theory

examine group decision making in strategic settings.

assume players can agree on their joint action, or can make binding
contracts.

simplifies strategic analysis by NOT modeling the negotiation
process explicitly.

⇒ The two tools are complements to one another, but this

lecture focuses mainly on Non-cooperative games.

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Timing and Information

Complete Incomplete
Information Information

Static Nash Equilibrium Bayesian NE

(Lecture 2-4) (Lecture 11-12)

Dynamic Subgame Perfect Perfect Bayesian

Equilibrium Equilibrium
(Lecture 5, 7-10) (not covered)

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Look into Games

We consider static situations in which each player
simultaneously chooses a strategy, and the combination of
strategies determines a payoff for each player.

The players need not literally act simultaneously.

Each chooses her own action without knowing others’ choices.

Formally, representation of a game specifies:

1. Players in the game.
2. Strategies available to each player.
3. Payoff received by each player (for every possible
combination of strategies chosen by the players).

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Example: Prisoners’ Dilemma

Two suspects are charged with a joint crime,
and are held separately by the police.

Each prisoner is told the following (assume

that a plea bargain is allowed):

If both confess, each receives 3 years imprisonment.

If neither confesses, both receive 1 year.

If one confesses and the other one does not, the
former will be set free immediately (0 payoff) and
the latter receives 5 years.

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Prisoners’ Dilemma: Payoff Matrix

Player 2 Silent Confess

Player 1
Silent -1 0
-1 -5
Confess -5 -3
0 -3

Here we set payoffs as (negative of) years.

Other numbers such that larger number shows better
outcomes can express the same situations.

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How to Use (Read) Bi-Matrices

Any two players game (with finite number of
strategies) can be expressed as a bi-matrix, called
payoff bi-matrix or payoff matrix.

The payoffs to the two players when a particular pair of
strategies is chosen are given in the appropriate cell.

The payoff to the row player (player 1) is given first, followed
by the payoff to the column player (player 2).

⇒ How can we solve this game?

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Prisoners’ Dilemma: Analysis
Player 2 Silent Confess
Player 1
Silent -1 0
-1 -5
Confess -5 -3
0 -3

(Silent, Silent) looks mutually beneficial outcomes, though

Playing Confess is optimal regardless of other player’s choice!

Acting optimally (Confess, Confess) rends up realizing!!

This is why the game is called Prisoners’ “Dilemma”.

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Prisoners’ Dilemma: Remarks

Playing “Confess” is optimal no matter how the
opponent takes “Confess” or “Silent.”

“Confess” is an optimal (dominant) strategy.

Combination of dominant strategies is Nash equilibrium.

There are many games where no dominant strategy exists.

Individually best decision ≠ Socially efficient outcome

Optimality for individuals does not necessary imply
optimality (Pareto efficiency) for a group or society.

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Terminology
Dominant strategy:

A strategy s is called a dominant strategy if playing s is
optimal for any combination of other players’
strategies.

Pareto efficiency:

An outcome of games is Pareto efficient if it is not
possible to make one person better off (through
moving to another outcome) without making
someone else worse off.

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Another Formulation of PD
Player 2 Cooperation Defection
Player 1
Cooperation 2 3
2 0
Defection 0 1
3 1

The larger the payoff, the better the corresponding result.

Desirability of outcomes for each player:

(D, C) > (C, C) > (D, D) > (C, D)

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Applications of PD

Examples Players “Cooperation” “Defection”

Arms races Countries Disarm Arm

International Countries Lower trade No change

trade policy barriers
Marital Couple Obedient Demanding
cooperation
Provision of Citizen Contribute Free-ride
public goods
Deforestation Woodmen Restrain cutting Cut down
maximum

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Example: Coordination Game

Player 2 Windows Mac

Player 1
Windows 1 0
1 0

Mac 0 2
0 2

Two students need a new computer each for joint-work.

Having different OS generates no value.

They (are assumed to) prefer (Mac, Mac) to (Win, Win)

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Coordination Game: Analysis

There is NO dominant (optimal) strategy.

Choosing Mac (Win) is optimal if the others is Mac (Win).

Best strategy varies depending on other’s choice.

Game cannot be solved merely from individual rationality.

Coordination game is NOT like Prisoner’s dilemma.

We need to look at Nash equilibrium!

(Mac, Mac) looks a unique reasonable outcome…

Let’s review the definition of Nash equilibrium!

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The Solution: Nash Equilibrium

John Nash discovered a path breaking solution
concept, called Nash equilibrium!

No one can benefit if she unilaterally changes her

action from the original Nash equilibrium.
⇒ NE describes a stable situation.

Everyone correctly predicts other players’ actions

and takes best-response against them.
⇒ NE serves as a rational prediction.

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Solving Coordination Game

There are two equilibria: (W, W) and (M, M).
⇒ Games, in general, can have more than one Nash
equilibrium.

Everybody prefers one equilibrium (M, M) to the

other (W, W).
⇒ Several equilibria can be Pareto-ranked.

However, bad equilibrium can be chosen.

⇒ This is called “coordination failure.”

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Example: Battle of the Sexes

A wife (player 1) and a husband (player 2) are supposed
to choose between going to a musical and a soccer game.

Presumably, the wife prefers the musical and the husband
the soccer game.
Player 2 Musical Soccer
Player 1
Musical 1 0
3 0

Soccer 0 3
0 1

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Example: Chicken Game

Two teenagers take their cars to opposite ends of main street
and start to drive toward each other.

The one who swerves to prevent a collision is the chicken and
the one who keeps going straight (tough) is the winner.

Player 2 Chicken Tough

Player 1
Chicken 2 3
2 0

Tough 0 -1
3 -1

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Further Exercises

Find a social problem which can be described as a
prisoner’s dilemma game.

Find a social problem which can be described as a
prisoner’s dilemma game.

Explain why rational decision made by each individual
does not necessarily result in socially optimal outcome (in
the presence of strategic interdependence).

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