Things I should know about Game Theory

Zhenyu Lai
December 14, 2009

1 Static Games of Complete Information

1.1 Preliminary Notation
∙ Space of “Strategy profiles”: 𝑆 = ×𝑖 𝑆𝑖 (Cartesian product of 𝑆𝑖 )
∙ 𝑠 ∈ 𝑆 means 𝑠 = (𝑠1 , 𝑠2 , . . . , 𝑠𝐼 ) where players. 𝑖 ∈ {1, 2, . . . , 𝐼}
∙ vN-M utility functions 𝑢𝑖 : 𝑆 → 𝑅
(Payoff of lottery over strategies = expected value of utility)
∑
∙ Mixed Strategy: 𝜎𝑖 ∈ 𝑖 (Probability distribution over 𝑆𝑖 )
Finite-dimension ‘probability simplex’: set of non-negative vectors in ℛ#𝑆𝑖
that sum to 1. ∑ ∑
Independence: 𝜎 ∈ ≡ ×𝑖 𝑖 is product measure on 𝑆𝑖
( )
∑ ∏𝐼
∙ Player i payoff to 𝜎 : 𝑠 𝑗=1 𝜎𝑗 (𝑠𝑗 ) 𝑢𝑖 (𝑠)

∙ Simplex: 𝑥 ∈ Δ2 if 𝑥1 + 𝑥2 = 1 where 𝑥1 , 𝑥2 > 0

1.2 Dominance
∙ Pure strategy 𝑠𝑖 is strictly dominated if there exists 𝜎𝑖′ such that 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 ) >
𝑢
(𝑖 (𝑠𝑖 , 𝜎−𝑖 ) for all 𝜎−𝑖 )
𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 ) > 𝑢𝑖 (𝑠𝑖 , 𝜎−𝑖 ) ∀𝜎−𝑖 ≡ 𝑢𝑖 (𝜎𝑖′ , 𝑠−𝑖 ) > 𝑢𝑖 (𝑠𝑖 , 𝑠−𝑖 ) ∀𝑠−𝑖 )

∙ Pure strategy can be dominated by mixed strategy even though it is not

dominated by any pure strategy.
∙ Mixed strategy 𝜎𝑖 is strictly dominated if there exists 𝜎𝑖′ such that 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 ) >
𝑢𝑖 (𝜎𝑖 , 𝜎−𝑖 ) for all 𝜎−𝑖
∙ Mixed strategy that assigns positive probability to strictly dominated pure
strategy is dominated. If all 𝑠𝑖 dominated, then 𝜎𝑖 is also dominated.
∙ Mixed strategy can be strictly dominated even though it doesn’t assign
positive probability to strictly dominated pure strategy.
∙ Best response: 𝜎𝑖 is a best response to 𝜎−𝑖 if it is an element of arg max𝜎𝑖′ 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 )
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∙ 2 player game: Strategy is strictly dominated iff there is no opponent’s
strategy to which it is a best response.
1.2.1 Iterated Strict Dominance
∙ Outcome of ISD does not depend on order of deletion. (Deleting strategies
of players -i won’t turn strictly dominated strategy into undominated one)
∙ 2 player games: ISD ≡ rationalizability (𝜎 is rationalizable only if it is a
BR to some 𝜎−𝑖 , i.e. BR to some rational beliefs)
∙ In finite game, ISD ends in finite number of rounds
∙ If ISD yields unique strategy profile, game is solved by ISD
∙ Assumes common knowledge of rational play
∙ Agents can be worse off with more choices. The following need not hold:
1. 𝐵 ⊆ 𝐴 ⇒ max𝑎∈𝐴 𝑢(𝑎) ≥ max𝑎∈𝐵 𝑢(𝑎)
2. ∀𝑎 ∈ 𝐴, 𝑢′ (𝑎) ≤ 𝑢(𝑎) ⇒ max𝑎∈𝐴 𝑢′ (𝑎) ≤ max𝑎∈𝐴 𝑢(𝑎)
∙ Player 1 can gain by actually making his outcomes worse because it might
change player 2’s strategy profile.
∙ Player 1 may also gain by making his information set worse.

1.2.2 Weak Dominance

∙ Pure strategy 𝑠𝑖 is weakly dominated if there exists 𝜎𝑖′ such that
1. 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 ) ≥ 𝑢𝑖 (𝑠𝑖 , 𝜎−𝑖 ) for all 𝜎−𝑖 , and
2. 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 ) > 𝑢𝑖 (𝑠𝑖 , 𝜎−𝑖 ) for at least one 𝜎−𝑖
∙ Weakly dominated strategies can be Nash equilibrium
∙ Weakly dominated strategy cannot be BR to totally mixed strategy.
∙ Iterated Weak Dominance (IWD): Order of deletion can matter (Deletion
can remove weak dominance)
∙ IWD not robust to even very small departures from common knowledge
of rationality.

1.3 Nash Equilibrium

∙ Strategy profile 𝜎 ∗ is a Nash equilibrium (NE) if for all players 𝑖,
𝑢𝑖 (𝜎𝑖∗ , 𝜎−𝑖
∗ ∗
∑
) ≥ 𝑢𝑖 (𝜎𝑖 , 𝜎−𝑖 ) ∀𝜎𝑖 ∈ 𝑖
∙ In any mixed strategy Nash equilibrium, all pure strategies with positive
probability must give same payoff.
∙ Strict Nash equilibrium need not exist.
∙ Only pure strategy equilibria can be strict.

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 ∙ In mixed strategy NE 𝜎, 𝑖 gets same payoff from playing any 𝑠𝑖 ∈ 𝑠𝑢𝑝𝑝𝑜𝑟𝑡(𝜎𝑖 )
when other players remain 𝜎−𝑖 , i.e. 𝑢𝑖 (𝜎𝑖 , 𝜎−𝑖 ) = 𝑢𝑖 (𝑠𝑖 , 𝜎−𝑖 ) = 𝑢𝑖 (𝑠′𝑖 , 𝜎−𝑖 )
(i.e. mixed strategy NE exists only if BOTH players randomize)
∙ Odd number of NE (usually)

Theorem 1. If a game is solvable by ISD, unique strategy profile that survives

ISD is unique NE of game. ISD never eliminates a Nash Equilibrium.

∙ Cournot Game (Pure strategy NE): 𝑢𝑖 = 𝑞𝑖 𝑝(𝑞1 + 𝑞2 ) − 𝑐𝑖 (𝑞𝑖 )

Reaction function 𝑟𝑖 (𝑞−𝑖 ) = arg max𝑞 𝑖 𝑢𝑖 (𝑞𝑖 , 𝑞−𝑖 )
∙ Principal-Agent Inspection Game (Unique mixed strategy NE):

Inspect Not Inspect

Shirk (0,−ℎ) (𝑤,−𝑤)
Work (𝑤 − 𝑔,𝑣 − 𝑤 − ℎ) (𝑤 − 𝑔,𝑣 − 𝑤)
Let 𝑦 be probability that 𝑃 inspects.
Let 𝑥 be the probability that 𝐴 shirks.

∙ Coordination Game (Multiple pure strategy NE)

Note: (A,B) and (B,A) is NE does not imply (A,A) is NE.

Solve: a) Experience of repeated play b)Focal points: Label Salience

A B C
A (0,0) (1,1) (0,0)
B (1,1) (0,0) (0,0)
C (0,0) (0,0) (1,1)

∙ Battle of the Sexes (Coordination game)

Football Ballet
Football (3,1) (0,0)
Ballet (0,0) (1,3)

1.4 Large population models

∙ Anonymous random matching (Future independent of current action)
∙ Aggregate statistic model (Payoff depends on aggregate distribution)
∙ Fictious Play: Believe opponents play fixed distribution. Bayesian update.

∙ Reinforcement Learning: Each action has reinforcement weight.

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1.4.1 Replicator Dynamic
Let 𝜙𝑡 (𝑠) be measure of players using pure strategy 𝑠 at date 𝑡
Let 𝜃𝑡 (𝑠) = ∑ 𝜙′ 𝑡𝜙(𝑠) ′
𝑡 (𝑠 )
be fraction of population playing strategy 𝑠
𝑠

𝑢𝑡 (𝑠) ≡ ∑ 𝑠′ 𝜃𝑡 (𝑠′ )𝑢(𝑠, 𝑠′ )

∑
Expected payoff of using pure strategy 𝑠:
Average expected payoff in population: 𝑢𝑡 = 𝑠 𝜃𝑡 (𝑠)𝑢𝑡 (𝑠)

Total # of Offspring (𝑠 strategists): 𝜙˙𝑡 (𝑠) = 𝜙𝑡 (𝑠)𝑢𝑡 (𝑠)

𝜙˙𝑡 (𝑠) 𝑠′ 𝜙𝑡 (𝑠′ ) − 𝜙𝑡 (𝑠) 𝑠′ 𝜙˙𝑡 (𝑠′ )
∑ ∑
Growth in Pop Share: ˙
𝜃𝑡 (𝑠) = ( )2 = 𝜃𝑡 (𝑠) [𝑢𝑡 (𝑠) − 𝑢𝑡 ]
′)
∑
𝑠′ 𝑡𝜙 (𝑠

Result: Solve for 𝜃˙𝑡 (𝑠). Find Eigenvalues

1. Real. -ve: Stable +ve: Unstable +/-: Unstable Saddle paths
2. Complex. -ve real component: Stable +ve real component: Unstable

1.4.2 Example: Rock Paper Scissors

Let 𝜃(𝑃 ) = 1 − 𝜃(𝑆) − 𝜃(𝑅), 𝑢𝑡 = 0
𝑢(𝑆) = −𝜃(𝑅) + 𝜃(𝑃 ) = 1 − 𝜃(𝑆) − 2𝜃(𝑅)
𝑢(𝑅) = 𝜃(𝑆) − 𝜃(𝑃 ) = 𝜃(𝑅) + 2𝜃(𝑆) − 1

˙
𝜃(𝑅) = 𝜃(𝑅)[𝜃(𝑅) + 2𝜃(𝑆) − 1 ]

˙
𝜃(𝑆) = 𝜃(𝑆)[1 − 𝜃(𝑆) − 2𝜃(𝑅) ]

Linearizing at equilibrium ( 31 , 13 ), Jacobian is:

˙
𝜃(𝑅) = [𝜃∗ (𝑅) + Δ𝜃(𝑅) ][𝜃∗ (𝑅) + Δ𝜃(𝑅) + 2𝜃∗ (𝑆) + 2Δ𝜃(𝑆) − 1 ]

1 2
= Δ𝜃(𝑅)𝜃∗ (𝑅) + 2Δ𝜃(𝑆)𝜃∗ (𝑅) = Δ𝜃(𝑅) + Δ𝜃(𝑆)
3 3
˙ 2 1
𝜃(𝑆) = −2Δ𝜃(𝑅)𝜃∗ (𝑆) − Δ𝜃(𝑆)𝜃∗ (𝑆) = − Δ𝜃(𝑅) − Δ𝜃(𝑆)
3 3
(˙ ) ( 1 2
)( )
𝜃(𝑅) 3 3
Δ𝜃(𝑅)
=
˙
𝜃(𝑆) − 23 − 13 Δ𝜃(𝑆)
Find Eigenvalues: 9𝜆2 + 3 = 0. Because real part = 0, system is degenerate.
If 𝜖 > 0: Unstable steady state NE. trajectories spiral out to simplex boundary.
If 𝜖 < 0: Asymptotically stable steady state NE for small 𝜖.
If 𝜖 = 0: cylicle behavior. Center is ESS only if 𝜖 > 0
(Note: 𝜖 here is when matched to self. Signs flip if payoff = 1 + 𝜖)

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 R S P
R (0,0) (1,-1) (-1,1)
S (-1,1) (0,0) (1,-1)
P (1,-1) (-1,1) (0,0)
∙ Every NE is a steady state. (Same average payoff. Constant pop share)
∙ Interior steady states must be NE. Boundary SS not necessarily NE.
∙ Non-Nash SS cannot be asymptotically stable. Perturbation grows share.
∙ No guarantee that replicator converges. But if they do, converge to NE.

1.5 Evolutionary Stable Strategy

∙ 𝜎 is evolutionary stable if 𝑢(𝜎, (1 − 𝜖)𝜎 + 𝜖𝜎 ′ ) > 𝑢(𝜎 ′ , (1 − 𝜖)𝜎 + 𝜖𝜎 ′ )
∙ 𝜎 is an ESS if:
1. 𝜎 is Nash Equilibrium.
2. 𝑢(𝜎, 𝜎) > 𝑢(𝜎 ′ , 𝜎)
3. If 𝑢(𝜎, 𝜎) = 𝑢(𝜎 ′ , 𝜎), then 𝑢(𝜎, 𝜎 ′ ) > 𝑢(𝜎 ′ , 𝜎 ′ ) (≥ if weak ESS)
∙ 2 player coordination game: Mixed strategy ( 21 , 12 ) is ESS because
𝑢(𝜎 ′ , (1 − 𝜖)𝜎 + 𝜖𝜎 ′ ) = (1 − 𝜖)𝑢(𝜎 ′ , 𝜎) + 𝜖𝑢(𝜎 ′ , 𝜎 ′ )
1 1
= (1 − 𝜖)( ) + 𝜖 𝑢(𝜎 ′ , 𝜎 ′ ) < 𝑢(𝜎, (1 − 𝜖)𝜎 + 𝜖𝜎 ′ ) =
2 | {z } 2
=0

∙ Any strict NE is an ESS and locally stable under replicator dynamic.

∙ All pure-strategy equilibria in static games are strict. ESS = Nash
∙ an interior ESS (fully mixed over all pure strategies) is unique if it exists
∙ 2-player, 2-pure strategy symmetric game always has an ESS

1.6 Nash Existence Theorem

Theorem 2 (Nash 1950). Every finite strategic-form game has a mixed
strategy Nash equilibrium.
Theorem 3 (Debreu, Glicksberg, Fan 1952). Consider an infinite
strategic-form game with:
1. a finite number of players
2. Strategy spaces 𝑆𝑖 which are nonempty, convex and compact subsets of
some Euclidean space ℛ𝑚 .
3. Payoff functions 𝑢𝑖 are continuous in 𝑠 and quasi-concave in 𝑠𝑖
There exists a Nash Equilibrium in pure strategies.

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1.6.1 Setup
→
∙ Correspondence 𝑟 : 𝑋 → 𝑌 is function from X to set of all subsets of Y.
→ ∑
∙ Fixed point 𝑟 : 𝑋 → 𝑋 such that 𝑥 ∈ 𝑟(𝑥). X is space of 𝜎(⋅)

∙ Set of agent 𝑖’s reaction correspondence BR: 𝑟𝑖 (𝜎) = arg max𝜎𝑖′ 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 )
∙ Correspondence because multiple BR. 𝑟𝑖 (𝜎) just depends on 𝜎−𝑖 , not 𝜎.
∙ Sufficiency by Kakutani’s fixed point theorem: Map 𝑟 has fixed point.
→
∙ Graph of correspondence 𝑟 : 𝑋 → 𝑌 is the set of ordered pairs

{(𝑥, 𝑦)∣𝑥 ∈ 𝑋, 𝑦 ∈ 𝑟(𝑥) }. Closed graph: This set is closed.

∙ Upper hemi-continuous: Correspondence 𝑟 from 𝑋 to 𝑌 is upper

hemi-continuous if for any 𝑥 ∈ 𝑋, and any open set 𝑉 ⊆ 𝑌 that contains
𝑟(𝑥), there is an open set 𝑈 that contains 𝑥 and such that 𝑟(𝑥′ ) ⊆ 𝑉 if
𝑥′ ∈ 𝑈 .
∙ Intuition: each player’s NE strategy does at least as well as any other
and thus cannot become strictly worse in the limit.
∙ Reaction correspondences need not be lower hemi-continuous: Strategy
that is not BR for any n can become a BR in the limit.
∙ Closed graph ≡ upper hemi-continuity when range 𝑌 of correspondence
is compact and 𝑟(𝑥) is closed for all 𝑥.

1.6.2 Proof
To use Kakutani sufficiency, prove 4 conditions:
∑
1. is a compact, convex, non-empty, finite-dimensional space.

Proof. Finite number of pure strategies

2. 𝑟(𝑥) is non-empty for all 𝑥.

∑
Proof. Payoff functions are continuous and is compact, so 𝑟𝑖 (𝜎) is
non-empty for all 𝑖 and 𝜎, so 𝑟(𝜎) is non-empty for all 𝜎.

3. 𝑟 is convex-valued.

Proof. Payoff functions 𝑢𝑖 are linear in player 𝑖’s probabilities, so 𝑟𝑖 (𝜎) is

a convex set for each player 𝑖, and thus so is 𝑟.

4. 𝑟 has closed graph.

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 Proof. Suppose graph is not closed. Then, ∃ sequence (𝜎 𝑛 , 𝜎 ˆ 𝑛 ) → (𝜎, 𝜎
ˆ)
𝑛 𝑛
such that 𝜎 ˆ ∈ 𝑟(𝜎 ) for all 𝑛 but 𝜎ˆ∈ / 𝑟(𝜎). Then, ∃ player 𝑖 such that
/ 𝑟𝑖 (𝜎), so ∃𝜖 > 0 and a 𝜎𝑖′ such that
𝜎ˆ𝑖 ∈

𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 ) > 𝑢𝑖 (𝜎ˆ𝑖 , 𝜎−𝑖 ) + 2𝜖

Since 𝑢𝑖 is continuous, and (𝜎 𝑛 , 𝜎 ˆ 𝑛 ) → (𝜎, 𝜎ˆ ), there is an 𝑁 such that for

all 𝑛 > 𝑁 , both ∣𝑢𝑖 (𝜎𝑖 , 𝜎−𝑖 ) − 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖
′ 𝑛
)∣ < 𝜖 and
∣𝑢𝑖 (ˆ 𝜎𝑖𝑛 , 𝜎−𝑖
𝜎𝑖 , 𝜎−𝑖 ) − 𝑢𝑖 (ˆ 𝑛
)∣ < 𝜖
Hence, for all such 𝑛, we have that

𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖
𝑛
) > 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖 ) − 𝜖 > 𝑢𝑖 (ˆ 𝜎𝑖𝑛 , 𝜎−𝑖
𝜎𝑖 , 𝜎−𝑖 ) + 𝜖 > 𝑢𝑖 (ˆ 𝑛
)

ˆ 𝑛 ∈ 𝑟(𝜎 𝑛 )
This contradicts the assumption that 𝜎

1.6.3 Intuition
Consider a family of games with the same finite strategy spaces 𝑆, and payoff
functions {𝑢𝑖 (𝑠, 𝜆) }𝑖∈𝐼 that are continuous functions of a parameter 𝜆, where
𝜆 lies in a compact set Λ. Then the correspondence 𝐸 that maps each 𝜆 to the
set of Nash equilibria for {𝑢𝑖 (𝑠, 𝜆) }𝑖∈𝐼 has closed graph. Loosely speaking, the
set of equilibria cannot suddenly shrink when in the limit 𝜆𝑛 → 𝜆.
L R
U (1,1) (0,0)
D (0,0) (𝜆,𝜆)
Number of equilibria can grow: 𝜆 < 0: 1 NE, 𝜆 = 0: 2NE, 𝜆 > 0: 3 NE

2 Dynamic Games of Complete Information

2.1 Setup for Extensive Form Games
∙ Games in extensive form must specify:
1. Set of players 𝑖 ∈ 𝐼
2. Who moves when
3. Feasible choices are at each decision point
4. What players have observed when they move
5. Payoffs to every possible outcome of the game (Complete
contingent payoffs)
6. Probability distributions over any exogenous random events.
∙ Partial Ordering: Elements need not be comparable

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 – Asymmetric - If 𝑥 ≻ 𝑥′ then not 𝑥′ ≻ 𝑥
– Transitive - If 𝑥 ≻ 𝑥′ and 𝑥′ ≻ 𝑥′′ , then 𝑥 ≻ 𝑥′′ .
∙ Precedence relation in game tree need not correspond to calendar time.
∙ Each node (except initial) has a unique “immediate predecessor ”

∙ Each successor corresponds to a different action.

∙ Information set: 𝑥′ ∈ ℎ(𝑥) implies that 𝑖(𝑥′ ) = 𝑖(𝑥) (Same player)
∙ Games of Perfect Recall: No player ever forgets anything they once
knew, and all players know their own past moves.

∙ Multistage games with Observed Actions:

1. At each stage, all players move simultaneously (no player moving at
stage 𝑘 knows about any other move at 𝑘) and each player moves at
most once per stage
2. All players at stage 𝑘 know the actions that were taken in all past
stages. Each player has a different information set at stage 𝑘 for
each possible sequence of past actions.
∙ Pure strategy (player 𝑖): 𝑠𝑖 : 𝐻𝑖 → 𝐴𝑖 such that ∀ℎ𝑖 , 𝑠𝑖 (ℎ𝑖 ) ∈ 𝐴(ℎ𝑖 ).
∏
∙ Space of player i’s pure strategies 𝑆𝑖 = ×ℎ𝑖 𝐴(ℎ𝑖 ). #𝑆𝑖 = ℎ𝑖 #(𝐴(ℎ𝑖 ))

2.2 Reduced Strategic Form

Definition 1. Two pure strategies 𝑠𝑖 , 𝑠′𝑖 of an extensive-form game are
equivalent if for all 𝑠−𝑖 , 𝜌(𝑠𝑖 , 𝑠−𝑖 ) = 𝜌(𝑠′𝑖 , 𝑠−𝑖 ) generate the same probability
distribution over terminal nodes. (𝜌(⋅) refers to the output function).

2.3 Behavior Strategies vs. Mixed Strategies

∙ Behavior strategy 𝑏𝑖 for player 𝑖 specifies a prob distribution over actions
in 𝐴(ℎ𝑖 ) for each information set ℎ𝑖 ∈ 𝐻𝑖 : 𝑏𝑖 ∈ ×ℎ𝑖 ∈𝐻𝑖 Δ(𝐴(ℎ𝑖 ))
∏
∙ “Many small randomizations”: ℎ𝑖 #𝐴(ℎ𝑖 ) with #𝐻𝑖 linear equalities.
∙ Mixed strategy 𝜎𝑖 ∈ Δ(𝑆𝑖 ) is prob distribution over 𝑠𝑖 (contingent plans)
∏
∙ “One big randomization”: ℎ𝑖 #𝐴(ℎ𝑖 ) with only 1 adding-up constraint.
∙ There is a unique behavior strategy equivalent to any given mixed
strategy. Set of mixed strategies is larger than set of behavior strategies.
∙ 2 strategies are equivalent if equal distribution across terminal nodes
1 1
∙ Mixed strategy: 2 (𝐿, 𝐿), 2 (𝐿, 𝑅). Behavior strategy: (𝐿, ( 12 𝐿, 12 𝑅))

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Theorem 4 (Kuhn). In a game of perfect recall, every mixed strategy is
equivalent to the behavior strategy it generates and every behavior strategy is
equivalent to every mixed strategy that generates it.
Proof. 1 Construct 𝑏𝑖 (𝑎∣ℎ) from 𝜎𝑖 . 2 Let 𝑅𝑖 (ℎ) be set of 𝑖’s pure strategies
that do not preclude ℎ ∈ 𝐻𝑖 , ie reach ℎ 3 If 𝜎𝑖 (˜(𝑠𝑖 )) > 0, bayesian update.

2.3.1 Example: Mixed vs. Behavior Strategy - Imperfect Recall

Player 1 - U or D. If U, Player 2 - A or B. If D, Player 2 - C or D.
Pure strategies: (A,C), (A,D), (B,C), (B,D)
Consider the mixed strategies: 𝜎2′ = ( 14 , 41 , 14 , 14 ), 𝜎2′′ = ( 12 , 0, 0, 12 )
Both mixed strategies generate behavior strategy 𝑏2 = ( 12 𝐴, 12 𝐵), ( 12 𝐶, 21 𝐷)

2.4 Self-Confirming Equilibrium

Definition 2. 𝜎 ˆ is a heterogeneous self-confirming equilibrium (SCE) if for
each player 𝑖 and each strategy 𝑠𝑖 ∈ 𝑠𝑢𝑝𝑝𝑜𝑟𝑡(𝜎) with 𝜎 ˆ𝑖 (𝑠𝑖 ) > 0 there exists
beliefs 𝜇𝑖 (𝑠𝑖 ) such that
1. 𝑠𝑖 maximizes player 𝑖’s payoff (BR) given his beliefs 𝜇𝑖 (𝑠𝑖 ), and

2. Beliefs 𝜇𝑖 (𝑠𝑖 ) is correct at every info set 𝑥 ∈ 𝑋(𝑠𝑖 , 𝜎

ˆ−𝑖 ) that is reached by
ˆ−𝑖 ) (1 consistent belief for EACH strategy ∀ℎ𝑗 ∈ 𝐻(𝑠𝑖 , 𝜎−𝑖 ))
(𝑠𝑖 , 𝜎

∙ Intuition: If always chooses ‘Stop’, never learns ‘Continue’ is better.

∙ SCE allows heterogeneous beliefs about off-path play.
∙ Intuition: Compare 1 A: Game ends. 1 B: 2 chooses C or D
1 chooses A or B, 2 simultaneously chooses C or D.
Same strategic form, different SCE
Randomization allows perfect recall. behavior strategy = all 𝜎

2.4.1 Example: SCE

Player 1 chooses A or D. If A, Player 2 chooses a or d. If (A,a), Payoff =
(1,1,1). If D or d, Player 3 gets to choose between L or R. If L, Payoff =
(3,0,0). If (D,R), Payoff = (0,3,x). If (d,R), Payoff = (0,3,y)
(A,a) is a SCE and not Nash. Even if Players 1 and 2 know x and y, they need
observations to learn 3’s play if x and y have opposite signs. (D,d if 𝑝(⋅) > 31 )

2.4.2 Differences in SCE vs. Nash

1. 2 players may have different beliefs about play of 3rd player
(Cannot arise in games of perfect information or 2 player games)
2. Player’s beliefs about off-path play of opponents correspond to
correlated strategy

9
 3. Different agents in role of different player can have different beliefs
4. Nature’s distribution not known a priori but has to be learnt. Even in
the 2 player game, players can have different beliefs about nature.

∙ SCE just requires each player 𝑖 to have any distribution of beliefs 𝜇𝑖 (𝑠𝑖 )
to rationalize each 𝑠𝑖 in the support of 𝜎 𝑖 . (e.g. many rep consumers)
∙ Unitary SCE requires each player 𝑖 to have the single belief 𝜇𝑖 about all
his strategies 𝑠𝑖 . (e.g. single govt actor) 𝑠𝑖 ∈ 𝑠𝑢𝑝𝑝𝑜𝑟𝑡(𝜎)

Definition 3. 𝜎 ˆ is a unitary self-confirming equilibrium (SCE) if for each

player 𝑖, there are beliefs 𝜇𝑖 and for each strategy 𝑠𝑖 with 𝜎
ˆ𝑖 (𝑠𝑖 ) > 0 such that

1. 𝑠𝑖 maximizes player 𝑖’s payoff (BR) given beliefs 𝜇𝑖 , and

2. Beliefs 𝜇𝑖 is correct at every information set 𝑥 ∈ 𝑋(ˆ
𝜎 ) that is reached in
equilibrium (1 consistent belief for EACH player ∀ℎ𝑗 ∈ 𝐻(𝜎))

2.4.3 Example: Heterogenous SCE that is not Unitary

Two-player Stackelberg game of complete information. Player 1 picks
𝑎1 ∈ {𝑈, 𝐷}. Player 2 observes 𝑎1 and plays 𝑎2 ∈ {𝑁, 𝐿, 𝑅} and game ends.
All player 1s know that 𝑎1 = 𝐷 leads to 𝑎2 = 𝑁 . Some player 1s think {𝑈, 𝐿}
so they play 𝐷. Other player 1s think {𝑈, 𝑅} so they play 𝑈 .
In heterogenous SCE, we can have a mixed strategy eqm: Some player 1s play
𝐷 (self-confirmed by 𝑁 ). Other player 1s play 𝑈 (self-confirmed by 𝑅).

∙ In static games, SCE = Nash equilibrium.

(Observing opponent’s chosen actions = Observing opponent’s strategy)

∙ In two-player games, Outcome of Unitary SCE = Outcome of NE

(> 2 players, Unitary SCE ⊃ NE. Inconsistent: 2 players disagree on 3rd)
(Same is true in n-player multi-stage games with observed actions and
‘independent beliefs’)
∙ Consistent: Beliefs correct at info set that 𝑖 can unilaterally reach

∙ Rational learning leads to objectively correct decisions if patient learners

get information about off-path play by experimenting.
∙ Ultimatum game: ‘unknowing’ losses (Self-cfrm) 3X > ‘knowing losses’

Theorem 5. Every SCE ≡ NE if 1) Consistent, 2) Independent beliefs, 3)

Unitary beliefs (eqm considers only pure strategy BR to single belief )

10
2.4.4 Example: Classic SCE Game
1 chooses {𝐴1 , 𝐷1 }
2 chooses {𝐴2 , 𝐷2 }
If (𝐴1 , 𝐴2 ), payoff = (1,1,1)
If 𝐷1 or 𝐷2 , 3 gets to play L: payoff = (3,0,0) or R: payoff = (0,3,0)

∙ (𝐷1 , 𝐴2 , 𝐿), (𝐴1 , 𝐷2 , ( 12 𝐿, 12 𝑅)) are NE & SCE (beliefs always correct)

∙ (𝐴1 , 𝐴2 , 𝐿) is unitary, inconsistent SCE. Wrong belief on off-path info set.

∙ (( 12 𝐴1 , 12 𝐷1 ), 𝐴2 , 𝐿) is a non-unitary, consistent SCE. Different beliefs.

2.5 Subgame Perfect Equilibrium

∙ NE too tight(Correct beliefs ∀ info sets): SCE - Off-path not restricted
∙ NE too loose: SPE - Equilibrium refinement
Deduce opponent’s off-path play from knowledge of opp’s payoffs.

Theorem 6 (Kuhn 1953). A finite game of perfect info has a pure strategy NE
Proof. Proof by backward induction to construct SPE. Need finite node to
start. Use continuity of player 2’s payoff and compactness of player 2’s action
set to ensure existence of BR. With perfect info, we can BI compute play.

∙ Long chains of BI risky and less compelling/robust.

∙ Why predict via BI when observed play has been inconsistent?

(BI restrict play at node BI says shouldn’t occur. Not robust small Δ)
∙ Prediction useful in complete theory: same 𝑠 given info set at each node.

Definition 4. A proper subgame 𝐺′ of an extensive form 𝐺 consists of a

single node 𝑥 and all of its successors in 𝐺, with the same precedence relation
(a “subtree”), and has the property that if 𝑥′ ∈ 𝐺′ and 𝑥′′ ∈ ℎ(𝑥′ ), then
𝑥′′ ∈ 𝐺′ : 𝐺′ doesn’t “cut up” any of the information sets of 𝐺. Inherits from 𝐺

Definition 5. A behavior strategy profile of an extensive form game 𝐺 is a

subgame-perfect equilibrium (SPE) if the restriction of the strategy to 𝐺′ is a
Nash equilibrium for every proper subgame 𝐺′ of 𝐺.

∙ SPE implies NE (SPE rules out non-credible threats)

∙ In one-shot simultaneous move games, SPE = NE
∙ In finite games of perfect information, SPE = Backwards induction

∙ In SPE, all players expect the same NE, but cannot deduce which NE

11
Theorem 7 (No Profitable One-Stage-Deviation). In a finite multi-stage
game with observed actions, strategy profile s is a SPE iff
No profitable OSD: there is no player i, and no 𝑠ˆ𝑖 that equals 𝑠𝑖 , except at a
single (𝑡, ℎ𝑡 ), such that 𝑢𝑖 ((ˆ
𝑠𝑖 , 𝑠−𝑖 )∣ℎ𝑡 ) > 𝑢𝑖 ((𝑠𝑖 , 𝑠−𝑖 )∣ℎ𝑡 ).
Proof. Necessity: Suppose OSD at ℎ𝑡 , then 𝑠 does not yield NE in subgame
starting at ℎ𝑡 , so not SPE.
Sufficiency: Suppose 𝑠 not SPE, then ∃(𝑡∗ , ℎ𝑡∗ ) where 𝑠 is not a NE. Thus, ∃
player 𝑖 and a strategy 𝑠′𝑖 better than 𝑠𝑖 , conditional on ℎ𝑡∗ being reached.
Definition 6. A (multi-stage) game is continuous at infinity iff
( )
∞ ∞
∀𝑖, 𝑙𝑖𝑚𝑡→∞ 𝑠𝑢𝑝over ℎ∞ ,ℎ̂∞ that agree for the first 𝑡 periods ∣𝑢𝑖 (ℎ )−𝑢𝑖 (ℎ̂ )∣ = 0

(Events in the distant future don’t matter much)

Theorem 8. OSD is necessary and sufficient for SPE in infinite-horizon
multi-stage games of observed actions that are continuous at infinity

2.5.1 Example: Timing Games - War of Attrition

𝑡
If game stops at 𝑡,player who stops gets −𝑐 1−𝛿
1−𝛿 and player who continues gets
𝑡
𝛿 𝑡 𝑣 − 𝑐 1−𝛿
1−𝛿 . If both stop at once, both gets 0.
Unique symmetric equilibrium is for each player to use the behavior strategy
“stop with probability 𝑝∗ at every information set” where 𝑝∗ = 𝑐/𝑣.

∙ Timing Games: Pre-emption (Patent race) - Intense & costly

competition when firms close, but when lead is large, both slow down.
∙ Discrete vs. Continuous time: cooperate & defect must be well-defined.
∙ On unit time period, there is no next-to-last period

2.5.2 Example: Rubinstein-Stahl Bargaining Model

∙ Players offer partition (𝑥, 1 − 𝑥). Once offer accepted, game ends.
∙ Finite version: SPE depends on who moves last, who has to accept. BI.
∙ Infinite version: SPE exists and is unique

In subgames where player 𝑖 starts with offer,

Let 𝑣 𝑖 , 𝑣 𝑖 be highest/lowest continuation payoff.
In subgames where player −𝑖 starts with offer,
Let 𝑤𝑖 , 𝑤𝑖 be highest/lowest continuation payoff.

∙ When player 1 makes offer, player 2 accepts if: 𝑣 1 ≥ 1 − 𝛿2 𝑣 2 .

∙ By symmetry, 𝑣 2 ≥ 1 − 𝛿1 𝑣 1

12
 ∙ Since player 2 never offers player 1 a share > 𝛿1 𝑣 1 , 𝑤 1 ≤ 𝛿1 𝑣 1

Player 2 obtain at least 𝑣 2 in continuation game by rejecting player 1’s offer

𝑣 1 ≤ max(1 − 𝛿2 𝑣 2 , 𝛿1 𝑤1 ) ≤ max(1 − 𝛿2 𝑣 2 , 𝛿12 𝑣 1 )

Also, max(1 − 𝛿2 𝑣 2 , 𝛿12 𝑣 1 ) = 1 − 𝛿2 𝑣 2 (else 𝑣 1 ≤ 𝛿12 𝑣 1 ⇒ 𝑣 1 ≤ 0)

∙ Thus, 𝑣 1 ≤ 1 − 𝛿2 𝑣 2 (1)
∙ By symmetry, 𝑣 2 ≤ 1 − 𝛿1 𝑣 1 (2)

Solving (1) & (2),

1 − 𝛿2
𝑣 1 ≥ 1 − 𝛿2 𝑣 2 ≥ 1 − 𝛿2 (1 − 𝛿1 𝑣 1 ) ⇒ 𝑣 1 ≥
1 − 𝛿1 𝛿2
1 − 𝛿2
𝑣 1 ≤ 1 − 𝛿2 (1 − 𝛿1 𝑣1 ) ⇒ 𝑣 1 ≤
1 − 𝛿1 𝛿2
1 − 𝛿2
𝑣1 ≤ 𝑣1 ⇒ 𝑣1 = 𝑣1 =
1 − 𝛿1 𝛿2
1 − 𝛿1 𝛿1 (1 − 𝛿2 ) 𝛿2 (1 − 𝛿1 )
𝑣2 = 𝑣2 = 𝑤1 = 𝑤1 = 𝑤2 = 𝑤2 =
1 − 𝛿1 𝛿2 1 − 𝛿1 𝛿2 1 − 𝛿1 𝛿2

2.6 Repeated Games with Observed Actions

∙ Repeated game: Always equilibrium to play static Nash eqm. More SPE.
∙ When sufficiently patient (𝛿 large), can support any larger action profile.

∙ Note: Equivalence - Same future play irregardless of history ℎ𝑡 or ℎ′𝑡

Theorem 9 (Friedman 1971). Let 𝛼∗ be a static equilibrium, let a be an

action profile with 𝑔𝑖 (𝑎) > 𝑔𝑖 (𝛼∗ ) for all players i. Then there is a 𝛿 < 1 such
that for all 𝛿 ∈ (𝛿, 1), there is an SPE in which a is played each period on the
equilibrium path.
Phase A: Each player 𝑖 plays 𝑎𝑖 . No deviation - Stay in A. Deviate - Go to B.
Phase B: Each player 𝑖 plays 𝛼𝑖∗ . Stay in Phase B forever.
Proof. Let 𝑜𝑣𝑒𝑟𝑙𝑖𝑛𝑒𝑣𝑖 − max𝑎 𝑔𝑖 (𝑎) and 𝑣𝑖 = 𝑔𝑖 (𝑎).
Sufficient condition for no profitable OSD in A: (1 − 𝛿)𝑣 𝑖 + 𝛿𝑔𝑖 (𝛼∗ ) < 𝑣𝑖 ∀𝑖
𝑣 𝑖 −𝑣𝑖
Prove theorem by set 𝛿 = max𝑖 𝑣𝑖 −𝑔 ∗
𝑖 (𝛼 )

13
2.7 Minmax
∙ Player 𝑖’s “minmax value” 𝑣 𝑖 = min𝛼−𝑖 [𝑚𝑎𝑥𝑎𝑖 𝑔𝑖 (𝑎𝑖 , 𝛼−𝑖 ) ]

∙ Player 𝑖’s payoff is at least minmax in any static eqm or Nash eqm

Theorem 10. Under full dimensionality, let 𝑎 be an action profile with

𝑔𝑖 (𝑎) > 𝑣 𝑖 for all 𝑖.Then, ∃𝛿 < 1 such that ∀𝛿 ∈ (𝛿, 1), there is an SPE in
which 𝑎 is played each period on equilibrium path.

∙ Pure strategy mutual minmax: action 𝑎∗ such that max𝑎′𝑖 𝑔𝑖 (𝑎′𝑖 , 𝑎∗−𝑖 ) ≤ 𝑣 𝑖
∙ Eqm strategies have to use rewards if no pure strategy mutual minmax
– Respond to deviation by playing 𝑎∗ for 𝑇 periods
– Check punishment period is long enough that no incentive to
deviate on eqm path
– Punishment period is short enough that each player 𝑖’s value at
start of punishment phase exceeds 𝑣 𝑖
∙ Use public randomizing device to coordinate correlated strategy.
∙ Single public randomization at start convexifies set of eqm outcomes
∙ Allowing public randomizations at later stages can introduce SPE that
are not in convex hull of equilibria of original game.

2.7.1 Example: Construct SPE - Payoff > Nash

Phase I: Play eqm collusion. If deviate, go to Phase II
Phase II: Minmax player for L periods. Minmax is Nash. Nobody deviates.

2.7.2 Example: Construct inequitable eqm - eqm < Nash

Phase I: Play eqm. If 1 deviate, go to II. If 2 deviate, go to III. Else, I
Phase II: minmax Nash player 1 forever.
Phase III: 1 plays absolute minmax 2 for L periods. If 1 deviates, go to II
Theorem 11. Assume a “full-dimensionality” condition. Then for every
feasible payoff vector 𝑣 for the LR players with 𝑣 𝑖 < 𝑣𝑖 < 𝑣 𝑖 for all 𝑖, there is a
𝛿 < 1 s.t. for all 𝛿 ∈ [𝛿, 1] there is a SPE with payoff vector 𝑣
Folk Theorem: With full-dimensionality, you can support a SPE in a repeated
game on a payoff for a player that is 𝜖 more than the player’s minmax value.

1. Trigger Strategies: Sustain any payoff above lowest NE payoff

2. Full-dimensionality strategies: Sustain any payoff above absolute minmax
3. 1 = 2 when eqm with lowest payoffs is also mutual minmax eqm.

14
Definition 7. Graph(B) is the set where all SR players are playing static BR
in every period.

𝛼 ∈ 𝑔𝑟𝑎𝑝ℎ(𝐵)𝑖𝑓 𝑓 𝛼𝑖 ∈ arg max

′
𝑢𝑖 (𝛼𝑖′ , 𝛼−𝑖 ) ∀𝑖 = 𝑗 + 1, . . . , 𝑛
𝛼𝑖

Graph B is the graph of the “Generalized Best Response Correspondence”

𝐵 : 𝐴1 × . . .𝑗 ⇒ 𝐴𝑗+1 × . . . × 𝐴𝑛

( )
minmax 𝑣 𝑖 = min max 𝑔𝑖 (𝑎𝑖 , 𝛼−𝑖 )
𝛼∈𝑔𝑟𝑎𝑝ℎ(𝐵) 𝑎𝑖

∙ LR Payoff is at least generalized minmax payoff

∙ Let 𝑣 𝑖 = max𝛼∈𝑔𝑟𝑎𝑝ℎ(𝐵) min𝑎𝑖 ∈𝑠𝑢𝑝𝑝𝑜𝑟𝑡(𝛼𝑖 ) 𝑔𝑖 (𝑎𝑖 , 𝛼−𝑖 )
( )

2.7.3 Example: Full dimensionality

L
l R
U 1,1,1 0,0,0
D 0,0,0 0,0,0
R
l R
U 0,0,0 0,0,0
D 0,0,0 1,1,1

∙ minmax = 0, dimension of feasible set = 1

∙ Impossible to support equilibria when payoffs of one player is lower than
1
4

Proof. Let 𝑎𝑖 be probability that player 𝑖 plays “first” pure strategy. For some
player 𝑖, it must be the case that for 𝑗 ∕= 𝑖 ∕= 𝑘, either 𝑎𝑗 ≥ 12 and 𝑎𝑘 ≥ 21 or
𝑎𝑗 ≤ 21 and 𝑎𝑘 ≤ 12 . But since player 𝑖 can obtain any convex combination of
𝑎𝑗 𝑎𝑘 and (1 − 𝑎𝑗 )(1 − 𝑎𝑘 ) as a payoff, he can get a payoff of at least 14 .

3 Static Games of Incomplete Information

3.1 Static Bayesian Games
3.1.1 Example: Entry game
Player 1 knows cost. Player 2 thinks Player 1’s cost either 1 or 3.
𝐼𝑛 Out
Build (0,−1) (2,0)
Don’t (2,1) (3,0)

15
 𝐼𝑛 Out
Build (1.5,−1) (3.5,0)
Don’t (2,1) (3,0)

Let 𝑝 = p(high cost), Let 𝑥 = p(1 builds ∣ low cost), Let 𝑦 = p(2 enters)
1
1 builds (x=1): 1.5𝑦 + 3.5(1 − 𝑦) > 2𝑦 + 3(1 − 𝑦) ⇒ 𝑦<
2
1
2 enters (y=1): 𝑝 + (1 − 𝑝)[−𝑥 + (1 − 𝑥)] > 0 ⇒ 𝑥<
2(1 − 𝑝)
Solve:
(x=0, y=1) is an equilibrium for any 𝑝.
(x=1, y=0) is an equilibrium if 𝑝 ≤ 12 .
1
(𝑥 = 2(1−𝑝) , 𝑦 = 12 ) is a mixed-strategy equilibrium if 𝑝 > 12 .
Convex hull for set of points X: minimal convex set that contains X. (i.e.
contains all possible convex combination of all the different equilibriums)
Definition 8. A Bayesian Nash equilibrium of an incomplete information
game with types 𝜃𝑖 ∈ Θ𝑖 , prior 𝑝 on Θ = ×𝑖 Θ𝑖 , pure strategy spaces 𝑆𝑖 , and
payoff functions 𝑢𝑖 : 𝑆 × Θ → ℛ, is a Nash equilibrium of the “expanded
game”, which is a strategic-form game with pure strategy spaces 𝑆𝑖Θ𝑖 (the set of
maps from Θ𝑖 to 𝑆𝑖 ) and payoff function 𝐸𝑝 𝑢𝑖 (𝑠(𝜃), 𝜃). So, 𝑠(⋅) is a pure
strategy Bayesian equilibrium if for each player 𝑖
∑ ( )
( ′ )
𝑠𝑖 (⋅) ∈ arg max 𝑝(𝜃)𝑢𝑖 𝑠𝑖 (𝜃𝑖 ), 𝑠−𝑖 (𝜃−𝑖 ) , 𝜃
Θ𝑖
𝑠′𝑖 ∈𝑆𝑖 𝜃

∙ Assume all types have positive probability so prior has full support.
∙ Thus, maximizing conditional expected payoff for every 𝜃𝑖 implies
maximizing ex-ante expected payoff. (⇐ all types have +ve probability)
∙ Nash existence thm applies. Finite Bayesian games have NE

∑ ∑ ( )
𝑠′𝑖 (𝜃𝑖 ), 𝑠−𝑖 (𝜃−𝑖 )
( )
𝑠𝑖 (⋅) ∈ arg max 𝑝(𝜃𝑖 ) 𝑝(𝜃−𝑖 ∣𝜃𝑖 )𝑢𝑖 ,𝜃
Θ𝑖
𝑠′𝑖 ∈𝑆𝑖 𝜃𝑖 𝜃−𝑖

3.1.2 Example: First-Price auction with type uncertainty

Let F(b) be cumulative bid distribution of high type. 𝑝(high type) = 𝑝
Mixed strategy can only be optimal if all strategies in it have equal utility.

( )
(𝜃ℎ −𝑏) (1 − 𝑝) + 𝑝𝐹 (𝑏) = (𝜃ℎ − 𝜃𝑙 − 𝜖)(1 − 𝑝)
| {z } | {z } | {z }
low type loses to high type p(beating high-type opponent payoff from bidding 𝜃𝑙 +𝜖

16
 1 − 𝑝 𝑏 − 𝜃𝑙
𝐹 (𝑏) = ⋅
𝑝 𝜃ℎ − 𝑏
Solve for highest bid in distribution by setting F(b) = 1 (no mass points)
𝑏 = (1 − 𝑝)𝜃𝑙 + 𝑝𝜃ℎ < 𝜃ℎ

3.2 Monotonicity
∙ With a continuum of actions, higher types play higher actions
∙ With a discrete set of actions and continuum of types, “cutoff rules”
exist: lowest interval of types play lowest action.

3.2.1 Example: Public good game

C N
C (1 − 𝑐1 ,1 − 𝑐2 ) (1 − 𝑐1 ,1)
N (1,1 − 𝑐2 ) (0,0)
∙ Pure strategy 𝑠𝑖 (𝑐𝑖 ) maps [𝑐, 𝑐] 7→ {0, 1}
∙ Let 𝑧𝑗 ≡ 𝑃 𝑟𝑜𝑏 𝑠∗𝑗 (𝑐𝑗 ) = 1 be eqm probability that player 𝑗 contributes.
( )

∙ Player 𝑖 contributes if cost < payoff: 𝑐𝑖 < 1 − 𝑧𝑗

∙ Monotonicity reduces dimensionality. All < cutoff-point will contribute.

At equilibrium, 𝑐∗𝑖 = 1−𝑃 (𝑐∗𝑗 ) = 1−𝑃 (1−𝑃 (𝑐∗𝑖 )) ⇒ 𝑐∗ = 1−𝑃 (𝑐∗ )

𝑐∗ 1 𝑐∗ 2
CDF:Uniform [0, 2] : 𝑐∗ = 1 − 𝑃 (1 − )=1− + ⇒ 𝑐∗ =
2 2 4 3

3.2.2 Example: Double Auction

Player 1 (Seller): 𝑢1 = 𝑏1 +𝑏
2
2
− 𝑐 if 𝑏1 ≤ 𝑏2 else 0
Player 2 (Buyer): 𝑢2 = 𝑣 − 𝑏1 +𝑏2
2
if 𝑏1 ≤ 𝑏2 else 0
∙ Pure strategy equilibria 𝑠𝑖 maps [0, 1] to [0, 1]
∙ Let 𝐹1 (𝑏) = 𝑃 𝑟 [𝑐 : 𝑠1 (𝑐) ≤ 𝑏] and 𝐹2 (𝑏) = 𝑃 𝑟 [𝑣 : 𝑠2 (𝑣) ≤ 𝑏]
∙ Let 𝑏′1 = 𝑠1 (𝑐′ ) and 𝑏′′1 = 𝑠1 (𝑐′′ )
∫ 1 ′ ∫ 1 ′′
𝑏 + 𝑏2 𝑏 + 𝑏2
( 1 − 𝑐′ )𝑑𝐹2 (𝑏2 ) ≥ ( 1 − 𝑐′ )𝑑𝐹2 (𝑏2 )
𝑏′1 2 𝑏′′
1
2
∫ 1 ′′ ∫ 1 ′
𝑏 + 𝑏2 𝑏 + 𝑏2
( 1 − 𝑐′′ )𝑑𝐹2 (𝑏2 ) ≥ ( 1 − 𝑐′′ )𝑑𝐹2 (𝑏2 )
𝑏′′
1
2 𝑏 ′
1
2
(𝑐′′ − 𝑐′ )(𝐹2 (𝑏′′1 ) − 𝐹2 (𝑏′1 )) ≥ 0

17
 ∙ Showing monotonicity, if 𝑐′′ > 𝑐′ , then 𝑏′′1 > 𝑏′1

∫ 1
𝑏1 + 𝑏2
max ( − 𝑐)𝑓2 (𝑏2 )𝑑𝑏2
𝑏1 𝑏1 2

∫ 𝑏(𝛼) ∫ 𝑏(𝛼)
𝑑 ∂ 𝑑𝑏(𝛼) 𝑑𝑎(𝛼)
Use Leibniz rule: 𝑓 (𝑥, 𝛼)𝑑𝑥 = 𝑓 (𝑥, 𝛼)𝑑𝑥+ 𝑓 (𝑏(𝛼), 𝛼)− 𝑓 (𝑎(𝛼), 𝛼)
𝑑𝛼 𝑎(𝛼) 𝑎(𝛼) ∂𝛼 𝑑𝛼 𝑑𝛼

1
FOC: [1 − 𝐹2 (𝑏1 )]−(𝑏1 −𝑐)𝑓2 (𝑏1 ) = 0 (many possible solutions, not Lipschitz continuous)
2
Strictly increasing equilibrium strategies (hence invertible):

𝐹2 (𝑏2 ) = 𝑃 𝑟 [𝑠2 (𝑣) ≤ 𝑏2 ] = 𝑃 𝑟 𝑣 ≤ 𝑠−1 −1

[ ]
2 (𝑏2 ) = 𝑃2 (𝑠2 (𝑏2 ))

1 𝑑𝑠−1
2 (𝑏2 ) 1
Inverse function theorem : (𝑓 −1 )′ (𝑏) = ′ ⇒ = 𝑑𝑠2 (𝑣)
𝑓 (𝑎) 𝑑𝑏2
| {z } 𝑑𝑣
| {z }
where 𝑏=𝑓 (𝑎) notice 𝑏2 =𝑠2 (𝑣)

Assume linear solution: 𝑠1 (𝑐) = 𝛼1 + 𝛽1 (𝑐) and 𝑠2 (𝑣) = 𝛼2 + 𝛽2 (𝑣)

𝑏 − 𝛼𝑖 𝑝𝑖 (𝑠−1
𝑖 (𝑏)) 1
𝐹𝑖 (𝑏) = 𝑃𝑖 (𝑠−1 −1
𝑖 (𝑏)) = 𝑠𝑖 (𝑏) = 𝑓𝑖 (𝑏) = 𝑑𝑠𝑖
=
𝛽𝑖 𝑑𝑏
𝛽𝑖

Plug into FOC, equating coefficients of 𝑐 and 𝑣, 𝛽1 = 𝛽2 = 23 , 𝛼1 = 14 , 𝛼2 = 1

12

3.2.3 Example: First-price auction

[ ]
Player 𝑖’s valuation is 𝜃𝑖 , distributed i.i.d over 𝜃, 𝜃 with prior 𝑃 , density 𝑝
𝑠𝑖 strictly monotone & continously differentiable. 𝑏𝑗 = 𝑠𝑗 (𝜃𝑗 ).
Let Φ𝑗 (𝑏𝑗 ) = 𝜃𝑗
| {z }
Φ maps bids to values

Type 𝜃𝑖 solves: max(𝜃𝑖 − 𝑏𝑖 )𝑃 (Φ𝑗 (𝑏𝑖 ))

𝑠(⋅)

FOC: 𝑃 (Φ𝑗 (𝑏𝑖 ) = (𝜃𝑖 − 𝑏𝑖 ) ⋅ 𝑝(Φ𝑗 (𝑏𝑖 ))Φ′𝑗 (𝑠)

| {z } | {z } | {z }
marginal cost surplus marginal gain in probabilities

Solve ODE and system of differential eqns to get eqm.

In symm eqm, let 𝑖 win if 𝜃𝑖 = Φ(𝑏) > 𝑌𝑖1 ≡ max𝑗∕=𝑖 𝑠(𝜃𝑗 ) (first-order statistic)

1
FOC: (𝜃−𝑏)𝐺′ (Φ(𝑏))Φ′ (𝑏) = 𝐺(Φ(𝑏)) where 𝜃 = Φ(𝑏), 𝑏 = 𝑠(𝜃), Φ′ (𝑏) =
𝑠′ (𝜃)

18
 𝑑
𝜃𝐺′ (𝜃) = 𝐺(𝜃)𝑠′ (𝜃) + 𝑠(𝜃)𝐺′ (𝜃) = 𝐺(𝜃)𝑠(𝜃)
𝑑𝜃
∫ 𝜃
Integrating both sides, 𝑠(𝜃)𝐺(𝜃) = 𝑡𝐺′ (𝑡)𝑑𝑡 + 𝑘
𝜃

Notice k = 0 because bidding 𝜃 never wins, thus 𝐺(𝜃) = 0

∫𝜃
𝜃
𝑡𝐺′ (𝑡)𝑑𝑡
Hence 𝑠(𝜃) = = 𝐸(𝑌𝑖1 ∣𝑌𝑖1 ≤ 𝜃)
𝐺(𝜃)

Expected payoff of type 𝜃 = 𝐺(𝜃)𝑠∗ (𝜃) = 𝐺(𝜃) ⋅ 𝐸(𝑌𝑖1 ∣𝑌𝑖1 ≤ 𝜃)

| {z } | {z }
Prob of winning bid

𝑁 −1
𝑃 ˜𝑈 [0, 1], 𝑃 (𝑥) = 𝑥, 𝐺(𝑥) = 𝑥𝑁 −1 , 𝐺′ (𝑥) = (𝑁 − 1)𝑥𝑁 −2 ⇒ 𝑠∗ (𝜃) = 𝑁 𝜃

3.2.4 Example: Second Price Auction

∙ Weakly dominant for each player to bid identity function 𝑏𝑖 (𝜃𝑖 ) = 𝜃𝑖 .
∙ Same expected revenue as shading bid in first-price.
∙ Note: Revenue equivalence does not hold when finite set of types.

3.2.5 Common Values - Winner’s Curse

Common Values Expected Payoff = 𝑃 𝑟(𝑏𝑖 > max 𝑏𝑗 )𝐸(𝑥−max 𝑏𝑗 ∣𝜃𝑖 , 𝑏𝑖 > max 𝑏𝑗 )
𝑗∕=𝑖 𝑗∕=𝑖 𝑗∕=𝑖

Winner’s curse because: 𝐸(𝑥∣𝜃𝑖 ) > 𝐸(𝑥∣𝜃𝑖 , 𝜃𝑖 > 𝑌𝑖1 )

∫ Φ(𝑏) ( )
𝜃𝑖 ’s payoff to bid 𝑏 is 𝑣(𝜃𝑖 , 𝑦) − 𝑣(𝑦, 𝑦) 𝐺′ (𝑦∣𝜃𝑖 )𝑑𝑦
𝜃

3.3 Harsanyi’s Purification Theorem

Mixed strategy NE is composed of pure strategy NE of perturbed games with
small errors. If players have a small shock to their payoffs with the correct
probabilities and play pure strategies in response to these shocks, resulting
play can look like mixed strategy NE.

3.3.1 Example: Grab the dollar w perturbation

I N
I (−1,−1) (1 + 𝜃1 ,0)
N (0,1 + 𝜃2 ) (0,0)
Mixed equilibrium: Each player plays ( 12 , 12 )
Symmetric pure strategy equilibrium: Each firm plays “Invest iff 𝜃𝑖 ≥ 0”

19
Theorem 12 (Harsanyi 1973). For a set of payoff vectors,
{𝑢𝑖 (𝑠)}𝑠∈𝑆,𝑖∈𝐼 ∈ ℛ#𝐼⋅#𝑆 of Lebesgue measure 1, for all independent priors on
Θ1 × . . . × Θ𝐼 with differentiable, strictly positive densities, and any
equilibrium 𝜎 of the complete-information game with payoffs 𝑢, the distribution
over 𝑆 induced by 𝜎 is the limit, as 𝜖 → 0, of the distributions over 𝑆 induced
by a sequence of pure-strategy equilibria of the corresponding Bayesian games.
For a fixed strategy space 𝑆, set of payoffs {𝑢𝑖 (𝑠)}𝑠∈𝑆,𝑖∈𝐼 ∈ ℛ#𝐼⋅#𝑆 of
Lebesgue measure 1

∙ Every NE can be purified

∙ Single distribution of types can purify game with multiple NE
∙ Single distribution of types can purify equilibria of many different games

Proof. ∙ BR of any player is “essentially pure”

∙ Because types have smooth density, probability of indifferent types = 0

∙ Smooth density allows single prior to purify any equilibria

∙ Each payoff just a perturbation. Only 𝑠 th component of 𝜃𝑖 matters
when 𝑠 is played.
∙ Lebesgue measure 1: restricts payoffs to full measure, ruling out lower
dimensional set of payoff vectors, letting us avoid games with NE in
weakly dominated strategies.

4 Dynamic Games of Incomplete Information

4.1 Dynamic Bayesian Games
∙ Each player’s strategy is a BR at EVERY information set, both on and
off the equilibrium path.
∙ Beliefs 𝜇(⋅∣𝑎1 ) maps 𝐴1 7→ Δ(Θ1 ) of distributions over Θ1 .
∙ PBE cannot be solved by BI. Strategies are optimal at every information
set given beliefs. Beliefs are consistent with strategies.

Definition 9. A Perfect Bayesian Equilibrium (PBE) of a signaling game is a

strategy profile 𝜎 ∗ and a belief function 𝜇 such that

Perfection: ∀𝜃1 , 𝜎1∗ (⋅∣𝜃1 ) ∈ arg max 𝑢1 (𝛼1 , 𝜎2∗ , 𝜃1 )

𝛼1
∑
∀𝑎1 , 𝜎2∗ (⋅∣𝑎1 ) ∈ arg max 𝜇(𝜃1 ∣𝑎1 )𝑢2 (𝑎1 , 𝛼2 , 𝜃1 )
𝛼2
𝜃1

20
 𝑝(𝜃)𝜎1∗ (𝑎1 ∣𝜃) ∑
Bayes: 𝜇(𝜃∣𝑎1 ) = ∑ ′ ∗ ′
𝑖𝑓 𝑝(𝜃′ )𝜎1∗ (𝑎1 ∣𝜃′ ) > 0
𝜃 ′ ∈Θ 𝑝(𝜃 )𝜎1 (𝑎1 ∣𝜃 ) 𝜃 ′ ∈Θ

∑
𝜇(𝜃∣𝑎1 ) is any probability distribution on Θ 𝑖𝑓 𝑝(𝜃′ )𝜎1∗ (𝑎1 ∣𝜃′ ) = 0
𝜃 ′ ∈Θ

PBE is simply a set of strategies and beliefs such that at any stage of the
game, strategies are optimal given the beliefs. And the beliefs are obtained
from equilibrium strategies and observed actions using Baye’s rule.

4.1.1 Example: Signaling Games

Player 1: Private info on own type. Plays 𝜎1 (⋅∣𝜃)
Player 2: Has prior beliefs 𝑝. Observes 1’s actions. Plays 𝜎2 (⋅∣𝑎1 )
∑∑
Player 1’s payoff: 𝑢1 (𝜎1 , 𝜎2 , 𝜃) = 𝜎1 (𝑎1 ∣𝜃)𝜎2 (𝑎2 ∣𝑎1 )𝑢1 (𝑎1 , 𝑎2 , 𝜃)
𝑎1 𝑎2
( )
∑ ∑∑
Player 2’s payoff: 𝑢2 (𝜎1 , 𝜎2 , 𝜃) = 𝑝(𝜃) 𝜎1 (𝑎1 ∣𝜃)𝜎2 (𝑎2 ∣𝑎1 )𝑢2 (𝑎1 , 𝑎2 , 𝜃)
𝜃 𝑎1 𝑎2

PBE vs BNE: In signaling game rules out any equilibria in which: following a
0-probability 𝑎1 , player 2 uses an 𝑎2 that isn’t a BR for any belief.

4.1.2 Example: Spence’s Education game

𝑎1
Player 1 (worker): Choose 𝑎1 . Obj function: 𝑎2 − 𝜃
Player 2 (firm): Minimise (𝑎2 − 𝜃)2

4.1.3 Monotonicity
Let 𝜎1′ and 𝜎1′′ denote eqm strategies of types 𝜃′ and 𝜃′′
Let 𝑎′1 ∈ 𝑠𝑢𝑝𝑝𝑜𝑟𝑡(𝜎1′ ) and 𝑎′′1 ∈ 𝑠𝑢𝑝𝑝𝑜𝑟𝑡(𝜎1′′ )

𝑎′1 𝑎′′
𝑎2 (𝑎′1 ) − ′
≥ 𝑎2 (𝑎′′1 ) − 1′
𝜃 𝜃
′′ ′
𝑎 𝑎
𝑎2 (𝑎′′1 ) − ′′1 ≥ 𝑎2 (𝑎′1 ) − ′′1
𝜃 𝜃
′′
Thus, ( 𝜃1′ − 1
𝜃 ′′ )(𝑎1 − 𝑎′1 ) ≥ 0 ⇒ 𝑎′1 ≤ 𝑎′′1

21
4.1.4 Separating Equilibrium
∙ Each type picks different action. support of each type’s strategy disjoint
∙ Low type’s action reveales type: equilibrium wage = 𝜃′
∙ By monotonicity, 𝑎′1 = 0. No mixed strategy, else play lower to still get 𝜃′

𝑎′′1
𝜃′ cannot defect: 𝜃′ ≥ 𝜃′′ − ⇒ 𝑎′′1 ≥ 𝜃′ (𝜃′′ − 𝜃′ )
𝜃′
𝜃′′ cannot defect: 𝑎′′1 ≤ 𝜃′′ (𝜃′′ − 𝜃′ )

Hence, 𝜃′ (𝜃′′ − 𝜃′ ) ≤ 𝑎′′1 ≤ 𝜃′′ (𝜃′′ − 𝜃′ )

∙ Suppose pessimistic belief: low type if action is not high, otherwise high
∙ BR: pay low-type wage to “non-high action”, high wage to “high action”
∙ No deviation, hence PBE. Note: Many feasible PBE for each action.

4.1.5 Pooling Equilibrium

Both types choose same action: ˜1 = 𝑎′1 = 𝑎′′1
𝑎
with wage = ex-ante expected productivity: 𝑎‘ ) = 𝑝′ 𝜃′ + 𝑝′′ 𝜃′′
𝑎2 (˜
𝑎
˜1
No deviation by low type: 𝜃′ ≤ 𝑝′ 𝜃′ + 𝑝′′ 𝜃′′ −
𝜃
This just requires: ˜1 ≤ 𝑝′′ 𝜃′ (𝜃′′ − 𝜃′ )
𝑎

∙ Pessimistic beliefs show this condition is sufficient.

˜1 ∈ [0, 𝑝′′ 𝜃1′ (𝜃1′′ − 𝜃1′ )] corresponds to pooling equilibrium.
∙ 𝑎
∙ Many “other equilibria”. Most efficient eqm: pooling at 𝑎1 = 0
∙ No mixed pooling eqm: Prefer lowest effort in support of pooling strategy

4.2 PBE in Multi-Stage Games with Observed Actions

∙ All players may have actions in each stage. (no need to be sequential)
∙ Each player 𝑖 may start game with private info and have type 𝜃𝑖 ∈ Θ𝑖
∙ Common prior 𝑝 on Θ = ×𝑖 Θ𝑖
∙ Each player’s strategy must be optimal, given opponent’s strategies &
beliefs, in each “continuation games” corresponding to each history ℎ𝑖 .
∙ In complete information games, PBE simplifies to SPE. Since there is a
single type for each player (i.e. fixed beliefs).

22
Definition 10. (𝜎, 𝜇) is a PBE in a two-player multi-stage game with
observed actions and independent types if:

∙ Perfection: Strategies are optimal at each history given beliefs

𝜇𝑖 (𝜎∣ℎ𝑡 , 𝜃𝑖 , 𝜇(⋅∣ℎ𝑡 )) ≥ 𝜇𝑖 ((𝜎𝑖′ , 𝜎−𝑖 )∣ℎ𝑡 , 𝜃𝑖 , 𝜇(⋅∣ℎ𝑡 ))) ∀𝑖, 𝜃𝑖 , 𝜎𝑖′ , ℎ𝑡

For 2/N players, beliefs satisfy the following conditions for each player 𝑖:

1. At every history, all types of player i have same beliefs

𝜇𝑖 (𝜃𝑗 ∣𝜃𝑖 , ℎ𝑡 ) = 𝜇𝑖 (𝜃𝑗 ∣𝜃𝑖′ , ℎ𝑡 ) = 𝜇𝑖 (𝜃𝑗 ∣ℎ𝑡 ) ∀𝜃𝑖 , 𝜃𝑖′ , 𝜃𝑗 , 𝑡, ℎ𝑡

Even unexpected observations do not make player 𝑖 believe that

opponent’s types are correlated. Posterior beliefs are independent.
2. Bayesian Updating. ∀𝑖, 𝑗, ℎ𝑡 , and 𝑎′𝑗 ∈ 𝐴𝑗 (ℎ𝑡 ),
If there is 𝜃ˆ𝑗 with 𝜇𝑖 (𝜃ˆ𝑗 ∣ℎ𝑡 )𝜎𝑗 (𝑎𝑡𝑗 ∣ℎ𝑡 , 𝜃ˆ𝑗 ) > 0, then

𝜇𝑖 (𝜃𝑗 ∣ℎ𝑡 )𝜎𝑗 (𝑎𝑡𝑗 ∣ℎ𝑡 , 𝜃𝑗 )

𝜇𝑖 (𝜎𝑗 ∣ℎ𝑡 , 𝑎𝑡 ) = ∑ ′ 𝑡 𝑡 𝑡 ′
𝜃 ′ ∈Θ𝑗 𝜇𝑖 (𝜃𝑗 ∣ℎ )𝜎𝑗 (𝑎𝑗 ∣ℎ , 𝜃𝑗 )
𝑗

When player 𝑖 deviates, Bayes rule is used to update all players -i,
whenever i’s period-t action has positive probability under period-t beliefs
(i.e. not a surprise). Includes off-the-path, so long as not impossible.
3. No signaling what you don’t know. ∀ℎ𝑡 , 𝑖, 𝑗, 𝑎𝑡 , 𝑎𝑡

𝜇𝑖 (𝜃𝑗 ∣ℎ𝑡 , 𝑎𝑡 ) = 𝜇𝑖 (𝜃𝑗 ∣(ℎ𝑡 , 𝑎𝑡 )𝑖𝑓 𝑎𝑡𝑗 = 𝑎𝑡𝑗

Player 𝑖 doesn’t use the play of other players to update beliefs about j,
even if j deviates. k’s action can’t have any information about j’s type.

4. Players 𝑖 and 𝑗 of independent type should have the same beliefs

about the type of a third player. ∀ℎ𝑡 , 𝜃𝑘 and 𝑖 ∕= 𝑗 ∕= 𝑘

𝜇𝑖 (𝜃𝑘 ∣ℎ𝑡 ) = 𝜇𝑗 (𝜃𝑘 ∣ℎ𝑡 ) = 𝜇(𝜃𝑘 ∣ℎ𝑡 )

23
4.3 Sequential Equilibrium
Definition 11. An assessment is a pair (𝜋, 𝜇) where 𝜋 is a strategy profile
and 𝜇 is a system of beliefs.
Definition 12. (𝜋, 𝜇) is sequentially rational if the action prescribed by 𝜋𝑖 (ℎ)
is optimal at each information set ℎ for player 𝑖(ℎ), given that opponents play
according to 𝜋−𝑖 and that beliefs over the nodes in ℎ are given by 𝜇.
Definition 13. (𝜋, 𝜇) is consistent if it is the limit of a sequence (𝜋 𝑛 , 𝜇𝑛 )
where each 𝜋 𝑛 is totally mixed and 𝜇𝑛 is derived from 𝜋 𝑛 by Bayes rule.
Definition 14. An assessment (𝜋, 𝜇) is a sequential equilibrium if it is
sequentially rational and consistent

∙ In SE, players with same observations must have same belifs: Beliefs of
all players are derived from the same sequence (𝜋 𝑛 , 𝜇𝑛 )
∙ Addtl SE req: Players have same interpretation of zero-problty events.

4.3.1 Example: PBE which is not SE

3
∙ 1 ends game by playing A only if both 2 & 3 play L with prob at least 4

∙ 3 plays R3 if believes 𝑝𝑟𝑜𝑏(𝑅1) > 13 . 2 plays R2 if believes 𝑝𝑟𝑜𝑏(𝐿1) > 1

3

∙ 2 & 3’s payoffs independent of each other’s moves. At least one plays R.
∙ Play A is according to Bayes: PBE. But not KW consistent: not SE

4.3.2 Notes about SE

∙ In signaling games, sequential equilibrium is equivalent to PBE
(consistent → Bayes. Off-path beliefs can be support by right trembles)

∙ But PBE does not imply Sequential Eqm. Additl consistency condition
(PBE does not track different orders of ‘zero problty’. Seq Eqm does.)
∙ Sequential equilibrium implies subgame-perfect equilibrium
∙ Seqential equilibrium ≡ SPE in games of perfect information.
(Because every information set is singleton. Every belief 𝜇 is point mass.)
∙ SE can differ on two extensive forms with same reduced strategic form.
∙ Every finite multistage game with observed actions and independent
types has a SPE. Every game has a SPE

∙ A NE which hits every info set with +ve probability is a sequential eqm.

24
Theorem 13. Consider a multi-stage game of incomplete information with
independent types. If either each player has at most two possible types
(#Θ𝑖 ≤ 2 for each 𝑖) or there are two periods, condition on beliefs = condition
on consistency, therefore the sets of PBE and Sequential Equilibria coincide.

∙ B1: all types of player 𝑖 have same beliefs about other players. player 𝑖
believes opponent’s types are independent.
∙ B2: Bayesian update, even off-path. +ve prob at t → +ve prob at 𝑡 + 1

∙ B3: Since player 𝑘 has no private info on 𝑗, even when perturb 𝑘’s strat:
𝑘’s action can’t signal j’s type. 𝑖 doesn’t use 𝑘 to update beliefs on 𝑗.
∙ B4: Players 𝑖 and 𝑗 have same beliefs about 𝑘

Theorem 14 (Kreps-Wilson 1982). For generic assignments of payoffs to

terminal nodes, the set of sequential-equilibrium probability distributions on
terminal nodes is finite.

∙ This is saying the payoff vectors are of lebesque measure 1

∙ i.e. components of eqm may have same outcomes with diff off-path play

4.3.3 Example: Repeated Provision of Public Good

∙ If costs independent over time: Both ‘contribute’ and ‘don’t’ will have
positive probability. All info sets are reached. PBE = SE
∙ Contribute less when repeated: Signals low cost, partner contributes less

Let equilibrium 1st period cutoff = 𝑐ˆ

Let equilibrium 2nd period cutoff = 𝑐𝑜

𝑃 (𝑐𝑜 ) − 𝑃 (ˆ
𝑐)
Neither player contributed: = 1 − 𝑐𝑜
1 − 𝑃 (ˆ𝑐)
1 − 𝑃 (𝑐𝑜 )
𝑐𝑜 = = 𝑃 𝑟(𝑐 > 𝑐𝑜 ∣𝑐 > 𝑐ˆ)
1 − 𝑃 (ˆ𝑐)
𝑃 (˜
𝑐)
Both players contributed: 1 − 𝑐˜ >
𝑃 (ˆ
𝑐)
𝑐) − 𝑃 (˜
𝑃 (ˆ 𝑐)
𝑐˜ = = 𝑃 𝑟(𝑐 > 𝑐˜∣𝑐 ≤ 𝑐ˆ)
𝑃 (ˆ
𝑐)

Player i contributed, Player j didn’t: 1 − 𝑐ˆ + 𝛿𝐸𝑉1 = 𝑃 (ˆ

𝑐) + 𝛿𝐸𝑉2

We know that type 𝑐ˆ will contribute in period 2 if opponent did not contribute
in period 1 to get utility (1 − 𝑐ˆ)

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 𝑃 (˜
𝑐)
𝐸𝑉1 = Expected cont. payoff if contribute: 𝑃 (ˆ
𝑐) ⋅ + [1 − 𝑃 (ˆ
𝑐)] (1−ˆ
𝑐)
|{z} 𝑃 (ˆ
𝑐)
𝑃 𝑟(opp contributes) | {z }
Payoff

𝐸𝑉2 = Expected cont. payoff if don’t: 𝑐) + [1 − 𝑃 (ˆ

𝑃 (ˆ 𝑐)] (1 − 𝑐ˆ)

Thus, 1 − 𝑐ˆ = 𝑃 (ˆ 𝑐) − 𝑃 (˜
𝑐) + 𝛿(𝑃 (ˆ 𝑐)) = 𝑃 (ˆ
𝑐) + 𝛿 𝑐˜
|{z} 𝑃 (ˆ
𝑐)
𝑃 (ˆ
𝑐)−𝑃 (˜𝑐)
Since 𝑐˜= 𝑃 (ˆ
𝑐)

If 𝛿 = 0, this is same as one-period game. As 𝛿 ↑→ 𝑅𝐻𝑆 ↑→ 𝑐ˆ ↓

∙ More patient → less likely for people to contribute

(more selfish, more likely to wait for others to contribute)
∙ If opponent’s type above 𝑐ˆ, 𝑖 will contribute irregardless.
∙ But if opponent’s type below 𝑐ˆ, 𝑖 gains continuation payoff from 1 − 𝑐˜ to
1 for gain of 𝑐˜ by not contributing.

4.4 Reputation Effects

∙ Strong in games with single LR player facing sequence of SR opponents

4.4.1 Example: Chain Store Game - No Reputation Effects

∙ Entrant: “tough” with probability q.
∙ Entrant’s Payoffs: 0 if out, -1 if (in,Fight), 𝑏 > 0 if (in,Accomodate)
𝑏
Normal Entrants choose “in” if they believe 𝑝(𝑓 𝑖𝑔ℎ𝑡) < 𝑏+1
Finite version unravels: Unique SPE - (Always accommodate, always enter)

∙ Incumbent’s payoff: a if out, -1 if (in,Fight), 0 if (in,Accomodate)

If 𝑎(1 − 𝑞) − 𝑞 > 0, Incumbent does better if public commit to “Always Fight”.

4.4.2 Example: Chain Store Game - With Reputation Effects

∙ Incumbent: “tough” with probability p, thus “Always Fights”
∙ Let 𝜇 be entrant’s subjective probability that incumbent is tough
𝑏
Last period: Soft Incumbent accomodates. Normal entrant plays in if 𝜇 < =𝑝
𝑏+1

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4.4.3 For 2 periods left:
𝑎−1
Case 1: −1+𝑎(1−𝑞) < 0 ⇒ 𝑞> ≡ 𝑞 ⇒ Incumbent accommodates
𝑎
Because Incumbent accomodates, normal Entrant plays “In” if 𝜇 < 𝑝

Case 2A: 𝑞 < 𝑞, 𝜇 > 𝑝 Incumbent fights today so normal E stays out tomorrow.

Incumbent payoff = [(1 − 𝑞)𝑎 − 𝑞] +(1 − 𝑞)𝑎

| {z }
payoff today

Case 2B: 𝑞 < 𝑞, 𝜇 < 𝑝 Mixed strategy equilibrium

Proof. No pure ‘always F’ pooling eqm: E enters anyway since 𝜇 < 𝑝
No pure ‘always A’ separating eqm: I fight, weak E stay away tomorrow.
Construct 𝜎: Once incumbent accomodates, he is revealed as soft → entry.
For indifferent incumbent: entrant must randomize if incumbent fights today.

1 𝜇
z }| { z }| {
𝑝(𝐹 ∣𝑇 ) 𝑝(𝑇 )
Normal entrant randomizes if 𝜇(𝑇 ∣𝐹 ) = 𝑝 =
𝑃 (𝐹 )
| {z }
𝑃 (𝑇 )𝑃 (𝑇 𝑓 𝑖𝑔ℎ𝑡𝑠)+𝑃 (𝑆)𝑃 (𝑆𝑓 𝑖𝑔ℎ𝑡𝑠)

𝑏 𝜇 𝜇
= ⇒ 𝛽=
𝑏+1 𝜇 + 𝛽(1 − 𝜇) (1 − 𝜇)𝑏
𝜇 𝑏+1
Total probability of fighting today: 𝜇+(1−𝜇)𝛽 = 𝜇+(1−𝜇) = 𝜇
(1 − 𝜇)𝑏 𝑏
𝑏+1 𝑏 𝑏 2
Soft entrant stays out if 𝑝(𝑓 𝑖𝑔ℎ𝑡) > 𝑝 ⇒ 𝜇> ⇒ 𝜇>( ) = 𝑝2
𝑏 𝑏+1 𝑏+1
If 𝑞 < 𝑞 and 𝜇 ∈ (𝑝2 , 𝑝), soft incumbent has positive equilibrium payoff in 2
period game. Conversely, if 𝜇 < 𝑝2 , normal entrant enters and soft
incumbent’s eqm payoff is 0.

4.4.4 For N periods

If (1 − 𝑞)𝑎 − 𝑞 > 0, unique equilibrium is such that for any prior 𝑝:
∙ More than n(p) stages left: weak incumbent fights with probability 1
∙ No normal entrant enters.

∙ Less than n(p) stages left: incumbent randomizes

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 ∙ p(tough) required to deter entry shrinks geometrically with 𝑛
∙ Thus, even small prior 𝑝 can have impact on long games.
∙ Sustain better commitment/ reputation with more types in model.

𝑃 𝑟(𝜃(𝑎)∣ℎ𝑡 )
Bayes: 𝑃 𝑟(𝜃(𝑎)∣(ℎ𝑡 , 𝑎𝑡 )) =
𝑞
Since BR have closed graph (As 𝑞 → 1, player 1 can’t lose a BR), ∃𝑞 < 1 s.t.
every BR for SR players for beliefs 𝑞 > 𝑞 is a BR they are certain LR plays 𝑎

Finite # of surprises (because 𝑃 𝑟(𝜃 = 𝜃(𝑎)) ≤ 1)

𝑝(𝜃(𝑎)) 𝑙𝑛(𝑝(𝜃(𝑎)))
# of surprises 𝑘 : ≤1 ⇔ 𝑘≤
𝑞𝑘 𝑙𝑛𝑞

LR’s worst payoff from commitment to “always a”: = min(𝑢1 (𝑎1 , 𝛼−1 )∣(𝑎1 , 𝛼−1 ) ∈ 𝑔𝑟𝑎𝑝ℎ(𝐵))

Payoff is at least BR of everybody else playing 𝛼−𝑖 . In the limit, if LR is

patient, he will be hurt less because the more he plays “surprise”, the less that
people think he will play “surprise” again.

∙ Stronger when more commitment types have +ve probability

∙ If actions imperfectly observed, beliefs evolve stochastically

4.5 Trembling-Hand Perfect Equilibrium

The following definitions are equilivant: A-¿C-¿B-¿A
Definition 15. An 𝜖-constrained equilibrium of a strategic form game is a
mixed strategy profile 𝜎 𝜖 such that for each player 𝑖, 𝜎𝑖𝜖 solves max𝜎𝑖 𝑢𝑖 (𝜎𝑖 , 𝜎−𝑖
𝜖
)
subject to 𝜎𝑖 (𝑠) ≥ 𝜖(𝑠𝑖 ) for some {𝜖(𝑠𝑖 )}𝑖,𝑠𝑖 where 0 < 𝜖(𝑠𝑖 ) < 𝜖
Strategy profile 𝜎 is trembling-hand perfect equilibrium if it is the limit of
𝜖-constrained equilibria 𝜎 𝜖 as 𝑒𝑝𝑠𝑖𝑙𝑜𝑛 → 0
Definition 16. Profile 𝜎 is a trembling-hand perfect equilibrium if there
exists a sequence of totally mixed strategy profiles 𝜎 𝑛 → 𝜎 such that for each
player 𝑖, 𝜎𝑖 ∈ arg max𝜎𝑖′ 𝑢𝑖 (𝜎𝑖′ , 𝜎−𝑖
𝑛
)
Definition 17. 𝜎 is a trembling-hand perfect equilibium if it is a limit of
𝜖-perfect equilibria 𝜎 𝜖 as 𝜖 → 0; 𝜎 𝜖 is 𝜖-perfect if it is totally mixed and for
each player 𝑖, any strategy that is not a BR to 𝜎 𝜖 has probability less than or
equal to 𝜖

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4.5.1 Example: Game of Perfect Info
Player 1: L1 or R1 which ends games with payoffs (2,2)
Player 2: L2 or R2 which ends games with payoffs (1,0)
Player 1: W1 with payoffs (3,1) or Z1 with payoffs (0,-5)

𝐿2 𝑅2
𝑅1 (2,2) (2,2)
𝑊1 (3,1) (1,0)
𝑍1 (0,−5) (1,0)

∙ Backwards Induction: (𝐿1 , 𝐿2 , 𝑊1 )

∙ t-h perfect: (𝑅1 , 𝑅2 ) because 𝑅2 is BR to (1 − 𝜖 − 𝜖2 , 𝜖2 , 𝜖)

∙ t-h perfect rules out all NE in weakly dominated strategies

(weakly dominated strategies never optimum against a mixed-strategy)

5 Problems
5.1 Finding Subgame Perfect Nash Equilibrium (SPNE)
∙ Specify strategies - each player’s actions at each information set.

∙ Check for mixed strategies at each node: Remember you cannot

randomize if not indifferent.

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