Chapter 4

Chapter 4
Games and Strategy

Definition of A Game
• Suppose Time magazine is considering which cover story to publish
next week. It has two alternatives to choose from: “Impeachment” or
“Financial Crisis.” “Impeachment” seems like a more promising story.
However, it is important for Time not to choose the same cover story
as Newsweek.
• Time’s dilemma illustrates the problem of interdependent decision
making: Time’s payoff depends not only on its own decision but also
on the decision of another player, Newsweek.
• A game is a model that depicts situations of strategic behavior, where the payoff
for one agent depends on its own actions as well as on the actions of other
agents
An example: Normal Form Representation
Three elements of a game:
Who are the players?
Which are the possible actions?
What are the payoffs?
Price competition has a

similar structure to the
prisoner’s dilemma. If you
rename the actions as:
L, T: Set high price
B, R: Set low price
Timing of the game
• This type of game is called static or simultaneous.
• But, does the players have to play simultaneously?
• What if one plays the action without observing the other’s action?
Dominant Strategy
• Whenever a player has a strategy that is strictly better than any other strategy regardless
of the other players’ strategy choices, we say that the first player has a dominant
strategy.
• In the prisoner’s dilemma game, is there a dominant strategy?
• If a player has a dominant strategy and if the player is rational, we should expect the
player to choose the dominant strategy. Notice that all we need to assume is that the
player is rational. In particular, we do not need to assume that the other players are
rational. In fact, we do not even need to assume that the first player knows the other
players’ payoffs. The concept of dominant strategy is very robust.
• However, not all the games have dominant strategy equilibrium.

Dominated Strategy-Definition
We define a dominated strategy as one whose payoff is inferior to that
of another strategy, regardless of what the other player does. The idea
is that, if a given player has a dominated strategy and that player is
rational, then we should expect the player not to choose such a
strategy.
Iterated Eliminiaton of Dominated Strategies
Are there any

dominant
strategies?
How about
dominated
strategies?
• T dominates M, M is dominated-> Good-bye

• R dominates C, C is dominated-> Good-bye
• B dominates T, T is dominated-> Good-bye
• Lastly, R dominates L, L is dominated-> Goodby
• So the solution to the IEDS is (B,R)
• The rationality assumption is important. You have to be sure that the
other person is rational in order for this solution concept to work.
Consider the following example:
What is the solution to IEDS?
If you are Player 1, would you be

confident to play B?
Nash Equilibrium
• A pair of strategies constitutes a Nash equilibrium if no player can
unilaterally change its strategy in a way that improves its payoff.
Nash Equilibrium
Is there a dominant strategy
equilibrium?
Is there an IEDS?
Is there a Nash Equilibrium?

Nash Equilibrium
Is there a Nash
Equilibria (more than
on equilibrium)?
Three solution concepts
• If a solution is Dominant Strategy than it is also IEDS
• If a solution is IEDS than it is also Nash. So a dominant strategy

equilibrium is also Nash.
• But the reverse is not true. (i.e Nash is not always IEDS)
Sequential Games-Extensive Form
• One player makes an action, the other observes and makes her
action.
• This is called sequential games and represented in extensive form in a

tree graph.
Sequential Games-Extensive Form (Example)
Who are the players?
What is the timing?
Where are the decision

nodes?
What are the Nash

Equilibria?
= = Is there an incredible
= threat?
What is the backward

induction solution?
Sequential Games-Extensive Form (Example)
• Commitment is of value.
• What if player 2 can commit to a strategy, delegate her power to a

lawyer and take a vacation? Is she better off?
Repeated Games
• Consider, however, the strategic phenomenon of retaliation, that is,
the situation whereby a player changes its strategic variable in
response to a rival’s action. Clearly, this cannot be achieved in a static,
simultaneous-move game, for in such game there is no time for a
player to react to another player’s actions.
Repeated Games (Example)
In a static game, there
are three actions for
player 1 and 3 actions
for player 2. If the same
game is played twice,
how many actions are
possible? A collection of
actions -> strategy.
Repeated Game Solution
There are two equilibria in the stage game (M, C) and (B,R). Since there are no other
stages, one of these will be played in the second stage.
Because players can react to other players’ past actions, repeated games allow for
equilibrium outcomes that would not be an equilibrium in the corresponding one
shot game.
In this game an equilibrium strategy for the first player is: Play T in the first stage, and
if player 2 plays L, play M, otherwise play B.
This is an equilibrium because the equilibrium actions give 5+4=9 for each player. If
one of the player’s deviate, the best she can do is get 6 in the first period, but would
only get 1 in the second period a total of 7.
Homework
• 4.3, 4.4, 4.6, 4.7, 4.8

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Chapter 4

Games and Strategy

Who are the players?

Which are the possible actions?

What are the payoffs?

Price competition has a

• This type of game is called static or simultaneous.

• But, does the players have to play simultaneously?

• In the prisoner’s dilemma game, is there a dominant strategy?

• However, not all the games have dominant strategy equilibrium.

Are there any

• T dominates M, M is dominated-> Good-bye

If you are Player 1, would you be

Is there a Nash Equilibrium?

• If a solution is Dominant Strategy than it is also IEDS

• If a solution is IEDS than it is also Nash. So a dominant strategy

• This is called sequential games and represented in extensive form in a

What is the timing?

Where are the decision

What are the Nash

What is the backward

• What if player 2 can commit to a strategy, delegate her power to a

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