Econ 221

Fall, 2021
Li, Hao
UBC

C HAPTER 1. B ASIC I DEAS AND E XAMPLES

1.1 What is a game of strategy

• Not all games are mainly about strategies.

• Not all strategizing happens in a game.

• Game of strategy: interactive decision making.

• Strategic thinking in a game of strategy.

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1.2 Some examples and stories of games of strategy

• Economics (auctions), political science (voting), international

relations (bargaining), biology (evolution).

• Sun Bin’s horserace strategy.

• King Solomon’s wisdom.

• Are animals capable of strategic thinking?

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 C HAPTER 2. H OW TO T HINK ABOUT G AMES OF S TRATEGY

2.2 Classifying games

• Sequential or simultaneous moves.

• Zero-sum or win-win, or somewhere in between.

• One-time encounter or repeated interactions.

• Perfect or imperfect information, and further in the latter

case, symmetric or asymmetric information.

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2.3 Some terminologies and background assumptions

• Strategies

– A strategy for a player in a given game is a complete

plan of actions.

– Same concept as any individual decision problem.

– The collection of feasible strategies for a player may be

too complex to fully describe.

– An outcome of the game is determined once we specify

a strategy for each player.

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• Payoffs

– To each outcome, a player attaches a number called

payoff, with a higher payoff preferred to a lower one.

– Maximizing one’s payoff is the objective of the player

in the game.

– Expected payoff: players rank uncertain outcomes by

computing mathematical expectation of their payoffs.

(For example, the expected payoff from 20% probability

of a payoff of 10 and 80% probability of a payoff of 20

is .2 × 10 + .8 × 20 = 18.)

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• Rationality

– Rational behavior: choose a strategy to maximize one’s

payoff given a belief about strategies other players choose.

– Rationality is thus best responding to what one believes

how others play.

– Most of our analysis assumes not only rationality of

each player but also common knowledge of each player’s

rationality among all players.

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• Equilibrium

– Equilibrium is Game Theory’s answer to: what strategy

will each player use in a given game?

– We have an equilibrium if each player uses a strategy

that best responds to strategies of other players.

– Equivalently, an equilibrium is reached when no single

player wishes to change strategy.

– Two features of equilibrium: non-cooperative, correct

beliefs.

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 C HAPTER 3. G AMES WITH S EQUENTIAL M OVES

3.1 Game trees

• A game tree is a graphical representation of a sequential-

move game.

– Each decision node is marked with the player who makes

the move, and the branches leading from the node, each

representing a possible move by the player.

– The initial node, or the root of the game tree, is the first

decision node.

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 Player 1

A B
Player 2 Player 2

C D E F G

(1, −2) (1, −1) (0, 2) (−2, 2) (1, 3)

Figure 1. An example with 2 players and 3 decision nodes.

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• Game tree continued.

– Each terminal node is marked with the payoffs to the

players, in the order of moves.

– A decision node marked with “Nature” represents some

external uncertainty outside the control of the players

in the game, and each branch leading from such a node

represents a possible resolution of the uncertainty and

is marked with the corresponding probability.

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 Player 1

A B
Player 2 Nature

C D E F 60% G 40%

(1, −2) (1, −1) (0, 2) (−2, 2) (1, 3)

Figure 2. An example with a Nature’s move.

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• A strategy of a player in a sequential-move game specifies a

move for each decision node that belongs to the player.

– A strategy of a player may specify moves at decision

nodes that will not be reached if the player follows the

strategy at earlier decision nodes.

– This is not only required for a strategy to be complete,

but also necessary for our analysis.

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 P1 P2 P1 P2 P1 P2
(6, 5)
C C C C C C

S S S S S S

(1, 0) (0, 2) (3, 1) (2, 4) (5, 3) (4, 6)

Figure 3. The Centipede Game: Player 1 has 8 strategies, 4 of

which lead to (1, 0).

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3.2 Solving games by using trees

• Entry Deterrence

– A start-up car-sharing company S decides whether or

not to enter a market monopolized by an incumbent

company I. If S does not enter, nothing happens. If S

enters, I has to decide whether to force S out (by cutting

the price) or to accommodate S; in the first case both

companies will lose money, while in the second case S

will make positive profit and I will make a positive but

smaller profit than if S does not enter.

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 S

Stay out Enter

I
(0, 2)
Fight Accommodate

(−1, −1) (1, 1)

Figure 4. Entry Deterrence.

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• Rollback: look ahead and reason back.

– Rollback is a necessary implication of strategic thinking

in a sequential-move game.

– Rollback equilibrium is game theory’s prediction of the

strategies that will be used by players in such a game.

• Rollback: the arrowhead form.

– Mark selected branches with arrows to find the rollback

equilibrium and the equilibrium outcome.

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 S

Stay out Enter

I
(0, 2)
Fight Accommodate

(−1, −1) (1, 1)

Figure 5. Rollback in Entry Deterrence.

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 P1 P2 P1 P2 P1 P2
(6, 5)
C C C C C C

S S S S S S

(1, 0) (0, 2) (3, 1) (2, 4) (5, 3) (4, 6)

Figure 6. Rollback in the Centipede Game.

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 P1

A B

P2 P2

C D E F G

(1, −2) (1, −1) (0, 2) (−2, 2) (1, 3)

Figure 7. Rollback in the example with 2 last moves.

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 P1

A B

P2 Nature

C D E F 60% G 40%

(1, −2) (1, −1) (0, 2) (−2, 2) (1, 3)

Figure 8. Rollback in the example with Nature’s move.

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 Proposer

0 1 50 100
Responder Responder Responder Responder

A R A R A R A R

          
100 0 99 0 50 0 0 0
0 0 1 0 50 0 100 0

Figure 9. The Ultimatum Game: first rollback.

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 Proposer

0 1 50 100
Responder Responder Responder Responder

A R A R A R A R

          
100 0 99 0 50 0 0 0
0 0 1 0 50 0 100 0

Figure 10. The Ultimatum Game: second rollback.

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3.4 Order advantages

• Compare two games of same two players and same move

for each player that differ only in who moves first.

– First-mover advantage: player gets a higher payoff when

he moves first than when he moves second, due to a

benefit from making commitment.

– Second-mover advantage: player gets a higher payoff

when he moves second than when he moves first, due

to benefit from retaining flexibility.

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 Firm A

Low High

Firm B Firm B

Low High Low High

(2, 2) (1, 3) (3, 1) (0, 0)

Figure 11. First-mover advantage.

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 Kicker

Le f t Right
Keeper Keeper

Le f t Right Le f t Right

(0.7, 0.3) (0.1, 0.9) (0.2, 0.8) (1, 0)

Figure 12. Second-mover advantage: Kicker moves first.

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 Keeper

Le f t Right

Kicker Kicker

Le f t Right Le f t Right

(0.3, 0.7) (0.9, 0.1) (0.8, 0.2) (0, 1)

Figure 13. Second-mover advantage: Keeper moves first.

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3.3 Adding more players

• Rollback method and rollback equilibrium generalize to more

than two players.

• Chain Store Game

– An incumbent firm I operates in K cities. In each city

k = 1, . . . , K, a start-up firm Sk plays Entry Deterrence

with I, after observing the outcome of previous k − 1

cities. Each Sk has cares only about the outcome in city

k, while I cares about sum of its payoffs across K cities.

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 S1

Out In
S2 I

Out In F A
I S2 S2
(0, 0, 4)
F A Out In Out In
I I
(0, −1, 1) (0, 1, 3) (−1, 0, 1) (1, 0, 3)
F A F A

(−1, −1, −2) (−1, 1, 0) (1, −1, 0) (1, 1, 2)

Figure 14. Chain Store Game with K = 2.

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