Eco514|Game Theory
1,Game Theory = Multiperson Decision Theory;
Zero-Sum games
Marciano Siniscalchi
September 16,1999
Administrative Stu
Class,Tue-Thu 10:40-12:10 [?],Room 317,Bendheim,OH,by appointment.
The Big Picture
Most of you will already have used some of the tools of GT in your core courses.
You will probably be familiar with the notions of simultaneous vs,extensive-form
game,perfect vs,imperfect information,complete vs,incomplete information,Nash
equilibrium,Perfect Bayesian equilibrium,Sequential equilibrium,etc,(but,don’t
worry if you are not).
This course has two main objectives,(1) introduce additional,perhaps more
sophisticated analytical tools,which you will most likely nd useful in your own work;
(2) enhance your understanding of the main ideas (as opposed to the main tools) of
GT,which includes (among other things) a critical appraisal of the applicability of
the techniques you have learned.
Under point (1),I will discuss,among other issues,sophisticated models of in-
complete information games which,for instance,allow one to think clearly about
currency speculation,bank runs and similar phenomena having to do with \mar-
ket sentiment"; forward induction,a powerful idea which pops up in many applied
models,from political economy to industrial organization; non-equilibrium solution
concepts,which we may view as a way to test the robustness of strategic predictions
to deviations from \textbook" settings; reputation phenomena,which may shed some
light on,say,a certain software behemoth’s unduly response to new entrants; and so
on.
1
However,in my mind,(2) is much more important than (1),The reason is that,
in my perhaps-not-so-humble opinion,GT is best viewed not as a \bag of tricks",
but as a methodology|a select collection of internally consistent,general principles
which helps you structure your own reasoning about strategic interaction in a given
setting.
Games as Multiperson Decision Problems
Decision theory enjoys an enviable status in economics,It is,often seen as the
prototypical example of a rigorous,well-founded theory,which is easy to apply to the
analysis of a wide variety of relevant decision situations in the social sciences,from
Econ 101-type models to GE and nance.
The link with GT might not be apparent,Indeed,it has been somewhat down-
played in the past,because certain conclusions one can draw from strategic reasoning
seem to be so much at odds with decision theory that the very existence of such a
link might appear questionable (think about,\more information can hurt you.")
However,the link is de nitely out there,and recent research has brought it to the
fore,What might be surprising is that the link was quite evident in the early days of
GT,when people were mostly interested in zero-sum games,I shall presently state
my case|and,in the process,review a related mathematical tool whose importance
I simply cannot overemphasize,linear programming.
Making the connection
First,I need to de ne a decision problem.
De nition 1 A decision problem is a tuple f ;C;Fg,where is a set of possible
states of the world,C is a set of consequences,and F C is a set of acts.
The idea is that,if the decision-maker (DM) chooses act f2F,and the prevailing
state is !2,then the consequence f(!)2C obtains,Consequences are supposed
to represent all the DM cares about.
The DM does not observe the prevailing state of the world,that is,there is
uncertainty about it,Still,she might be assumed to exhibit preferences (represented
by a binary relation F F) among available acts,The classical \representation"
result exhibits a set of joint assumptions about (and F) which are equivalent to
the existence of a probability measure 2 ( ) and a utility function u,C ! R
(unique up to a positive a ne transformation) which represents,
8f;g2F; f g,
Z
u(f(!)) (d!)
Z
u(g(!)) (d!)
2
Next,let us de ne simultaneous games:
De nition 2 A nite simultaneous game is a tuple fN;(Ai;ui)i2Ng,where N is a
nite set of players,and for each player i2N,Ai is a nite set of actions and ui is a
payo function ui,Ai A i!R.
(I use the conventional notation A i = Qj6=iAj and A = Qi2N Ai.) We could be
more general and assume that each player is endowed with a preference relation over
action pro les,but let’s not worry about this right now.
The above is the \standard" de nition of a game,As you may see,it is not quite
consistent with the de nition of a decision problem,so we need to reinterpret things
a bit.
Indeed,the most important di erence is that a game implicitly de nes not just
one,but N decision problems (with a conventional abuse of notation,I will denote
by this both the set N and its cardinality jNj).
Let’s take the point of view of Player i,She has no control over her opponents’
choices,and she will not nd out what they were until the game is over,Thus,A i
seems a good candidate for the state space,= A i.
Next,utilities are attached to points (ai;a i) 2 A according to De nition 2.
This amounts to saying that there is a one-to-one correspondence between the actual
outcome of the game (which is what players care about) and action pro les,Thus,
we may as well imagine that action pro les are the relevant consequences,C = A.
By a process of elimination,acts must be actions,\F = A00i,Formally,action
ai2Ai de nes an act fai,A i!Ai A i (i.e,fai,!C) by fai(a i) = (ai;a i).
However,the de nition of a game incorporates additional information,speci cally,
it includes a utility function for each player,This implies that we have a complete
description of players’ preferences among consequences,However,in view of the
representation results cited above,this is only one part of the description of players’
preferences among acts,because the probabilities are missing.
This trivial observation is actually crucial,in some sense,the traditional role of
game theory has been that of specifying those probabilities in a manner consistent
with assumptions or intuitions concerning strategic rationality.
Nash Equilibrium
To make this more concrete,recall what you may have heard about Nash equilibrium:
a player’s strategy doubles as her opponents’ beliefs about her strategy.
Thus,in a 2-player game,a Nash equilibrium is a speci cation of beliefs ( 1; 2)
for both players,with the property that if Player i’s belief assigns positive probability
to an action aj2Aj (j6= i),then the act faj is preferred by j to any other act,given
that j’s preferences are represented by the utility function uj,A ! R and the
3
probability measure i 2 (Ai) (note the indices!),In short,we say \aj is a best
reply to i".
Note,at rst sight,Nash equilibrium seems to say that players’ beliefs are required
to be \consistent with rationality",However,note that,since the rationality of an
act can only be assessed with respect to a given (utility function and) probability
measure over states of the world,the de nition really says that players’ beliefs are
required to be \consistent with rationality,given the equilibrium beliefs." We shall be
more speci c about this point in a subsequent lecture.
Also,note that this interpretation of Nash equilibrium has no behavioral content:
it is simply a restriction on beliefs,If we really wish to push this to the extreme,
we can say that,if players’ belief satis es the restrictions in the de nition of a Nash
equilibrium,then the players may choose an action that is a best reply to those beliefs.
Again,we will return to this point later in the course.
Zero-Sum games and the minmax solution
Game theorists were originally interested in a much simpler class of games,namely
two-player games in which interests were diametrically opposed:
De nition 3 A two-player simultaneous game ff1;2g;(Ai;ui)i2Ng is zero-sum i,
for all a2A,u1(a) +u2(a) = 0.
To put this in perspective,think about board games such as chess or checkers,or
war.
In the latter case,it appears that doing one’s best in the worst-case scenario might
be the \right" thing to do,I am told this is what they teach you in military academy,
anyway.
In a zero-sum game,the worst-case scenario for Player 1 is also the best scenario
for Player 2,and vice-versa,Thus,for Player 1 to assume that Player 2 is \out to
get her" is not inconceivable|after all,Player 2 has all the right incentives to do so.
This idea leads to the notion of maxmin and minmax strategies,Suppose rst that
both players can randomize|commit to spinning roulette wheels or something like
that,so as to choose strategies according to any pre-speci ed probability i2 (Ai).
We will get back to this later in the course,for now,let’s just assume that this is
possible; the reason why this is convenient will become clear momentarily,Again
using a conventional notation,let u1( 1; 2) =,P(a1;a2)2Au1(a1;a2) 11(a1) 12(a2) for
any ( 1; 2)2 (A1) (A2).
Consider rst a pair of mixed strategies 1i 2 (Ai),i = 1;2,such that
u1( 11; 12) = min
22 (A2)
max
12 (A1)
u1( 1; 2)
4
In words,u1( 11; 12) is the minimum payo that Player 1 can secure; equivalently,it
is the minimum payo to Player 1 when Player 2 attempts to damage her as much
as possible,while keeping into account the fact that Player 1 best-responds.
Note that since max f = minf,
u2( 11; 12) = u1( 11; 12) = max
22 (A2)
min
12 (A1)
u2( 1; 2)
i.e,( 11; 12) also yields Player 2 the maximum payo he can obtain if Player 1 chooses
her mixed strategy so as to hold Player 2’s payo down.
Such a pair of mixed strategies can always be found (why?),Similarly,one can
consider the symmetric problem for Player 2,and de ne a new pair ( 21; 22) such that
u2( 21; 22) = min
12 (A1)
max
22 (A2)
u2( 1; 2)
so u2( 21; 22) is the minimum payo that Player 2 can secure; as above,
u1( 21; 22) = max
12 (A1)
min
22 (A2)
u1( 1; 2)
the maximum payo that Player 1 can obtain if Player 2 attempts to hold Player 1’s
payo down.
It may be helpful to think about this as a \pseudo-dynamic" story,in order to
de ne ( 11; 12),one imagines that Player 2 chooses rst,and Player 1 moves next;
the latter best-responds to Player 2’s choice,and the former,anticipating 1’s best
response,attempts to minimize Player 1’s payo,On the other hand,to de ne
( 21; 22),one imagines that Player 1 chooses rst,and Player 2 moves next; the latter
observes 1’s choice and attempts to minimize 1’s payo,while the former,anticipating
this,attempts to maximize her own payo,[Of course there is a dual to this story,
with 1’s and 2’s roles inverted.]
It is natural to ask whether Player 1’s resulting payo under the two de nitions
is the same,The answer is a rmative:
Theorem 0.1 (a.k.a,\The minmax theorem"),there exists a pair ( 1; 2)2 (A1)
(A2) such that
u1( 1; 2) = max
12 (A1)
min
22 (A2)
u1( 1; 2) = min
22 (A2)
max
12 (A1)
u1( 1; 2)
The easiest proof of this theorem uses Linear Programming,Let ni be the cardi-
nality of Ai and number its elements from 1 to ni; de ne the n1 n2 matrix U by
letting Uk‘ = u1(ak1;a‘2),where ak1 and a‘2 are the k-th and ‘-th elements of A1 and A2,
respectively,Then Player 1’s (2’s) beliefs about Player 2’s choices may be represented
as nonegative vectors in 2 2Rn2 (resp,1 2Rn1) whose elements add up to one.
5
Consider the following problem:
min
2
u s.to U 2 + 1u 0; 10 2 = 1
which we can interpret as follows,Player 2 chooses 2 so that every strategy of Player
1 yields u or less; indeed,Player 2 attempts to make u as small as possible,Note
that u is unconstrained in sign.
The dual program is
max
1
v s.to 01U + 10v 0; 011 = 1
i.e,Player 1 chooses 1 so each of Player 2’s strategy yields at least v to Player 1
(think about it!),i.e,at most v to Player 2,Again,v is unconstrained.
Note that both programs are feasible (easy); also,both programs are bounded,
because,say,in the dual program,v cannot be larger than the largest entry in the
matrix U (which,if you think about it,is also obvious!) But then,by the Existence-
Duality theorem of LP,both programs have optimal solutions,the optimal values are
the same (so u = v),and the optimal solutions are complementary,In particular,
this means that 1(a1) > 0 implies u1(a1; 2) = u,and similarly for 2,Thus,only
actions which achieve the maximal payo u against 2 receive positive probability;
in other words,1 only assigns positive probabilities to best responses (and similarly
for 2),Hence,the optimal solutions of the dual LPs identify a Nash equilibrium; it
is then easy to see that any Nash equilibrium satis es the equality in Theorem 1 (see
Proposition 22.2 in OR if you don’t see this),and we are done.
6
1,Game Theory = Multiperson Decision Theory;
Zero-Sum games
Marciano Siniscalchi
September 16,1999
Administrative Stu
Class,Tue-Thu 10:40-12:10 [?],Room 317,Bendheim,OH,by appointment.
The Big Picture
Most of you will already have used some of the tools of GT in your core courses.
You will probably be familiar with the notions of simultaneous vs,extensive-form
game,perfect vs,imperfect information,complete vs,incomplete information,Nash
equilibrium,Perfect Bayesian equilibrium,Sequential equilibrium,etc,(but,don’t
worry if you are not).
This course has two main objectives,(1) introduce additional,perhaps more
sophisticated analytical tools,which you will most likely nd useful in your own work;
(2) enhance your understanding of the main ideas (as opposed to the main tools) of
GT,which includes (among other things) a critical appraisal of the applicability of
the techniques you have learned.
Under point (1),I will discuss,among other issues,sophisticated models of in-
complete information games which,for instance,allow one to think clearly about
currency speculation,bank runs and similar phenomena having to do with \mar-
ket sentiment"; forward induction,a powerful idea which pops up in many applied
models,from political economy to industrial organization; non-equilibrium solution
concepts,which we may view as a way to test the robustness of strategic predictions
to deviations from \textbook" settings; reputation phenomena,which may shed some
light on,say,a certain software behemoth’s unduly response to new entrants; and so
on.
1
However,in my mind,(2) is much more important than (1),The reason is that,
in my perhaps-not-so-humble opinion,GT is best viewed not as a \bag of tricks",
but as a methodology|a select collection of internally consistent,general principles
which helps you structure your own reasoning about strategic interaction in a given
setting.
Games as Multiperson Decision Problems
Decision theory enjoys an enviable status in economics,It is,often seen as the
prototypical example of a rigorous,well-founded theory,which is easy to apply to the
analysis of a wide variety of relevant decision situations in the social sciences,from
Econ 101-type models to GE and nance.
The link with GT might not be apparent,Indeed,it has been somewhat down-
played in the past,because certain conclusions one can draw from strategic reasoning
seem to be so much at odds with decision theory that the very existence of such a
link might appear questionable (think about,\more information can hurt you.")
However,the link is de nitely out there,and recent research has brought it to the
fore,What might be surprising is that the link was quite evident in the early days of
GT,when people were mostly interested in zero-sum games,I shall presently state
my case|and,in the process,review a related mathematical tool whose importance
I simply cannot overemphasize,linear programming.
Making the connection
First,I need to de ne a decision problem.
De nition 1 A decision problem is a tuple f ;C;Fg,where is a set of possible
states of the world,C is a set of consequences,and F C is a set of acts.
The idea is that,if the decision-maker (DM) chooses act f2F,and the prevailing
state is !2,then the consequence f(!)2C obtains,Consequences are supposed
to represent all the DM cares about.
The DM does not observe the prevailing state of the world,that is,there is
uncertainty about it,Still,she might be assumed to exhibit preferences (represented
by a binary relation F F) among available acts,The classical \representation"
result exhibits a set of joint assumptions about (and F) which are equivalent to
the existence of a probability measure 2 ( ) and a utility function u,C ! R
(unique up to a positive a ne transformation) which represents,
8f;g2F; f g,
Z
u(f(!)) (d!)
Z
u(g(!)) (d!)
2
Next,let us de ne simultaneous games:
De nition 2 A nite simultaneous game is a tuple fN;(Ai;ui)i2Ng,where N is a
nite set of players,and for each player i2N,Ai is a nite set of actions and ui is a
payo function ui,Ai A i!R.
(I use the conventional notation A i = Qj6=iAj and A = Qi2N Ai.) We could be
more general and assume that each player is endowed with a preference relation over
action pro les,but let’s not worry about this right now.
The above is the \standard" de nition of a game,As you may see,it is not quite
consistent with the de nition of a decision problem,so we need to reinterpret things
a bit.
Indeed,the most important di erence is that a game implicitly de nes not just
one,but N decision problems (with a conventional abuse of notation,I will denote
by this both the set N and its cardinality jNj).
Let’s take the point of view of Player i,She has no control over her opponents’
choices,and she will not nd out what they were until the game is over,Thus,A i
seems a good candidate for the state space,= A i.
Next,utilities are attached to points (ai;a i) 2 A according to De nition 2.
This amounts to saying that there is a one-to-one correspondence between the actual
outcome of the game (which is what players care about) and action pro les,Thus,
we may as well imagine that action pro les are the relevant consequences,C = A.
By a process of elimination,acts must be actions,\F = A00i,Formally,action
ai2Ai de nes an act fai,A i!Ai A i (i.e,fai,!C) by fai(a i) = (ai;a i).
However,the de nition of a game incorporates additional information,speci cally,
it includes a utility function for each player,This implies that we have a complete
description of players’ preferences among consequences,However,in view of the
representation results cited above,this is only one part of the description of players’
preferences among acts,because the probabilities are missing.
This trivial observation is actually crucial,in some sense,the traditional role of
game theory has been that of specifying those probabilities in a manner consistent
with assumptions or intuitions concerning strategic rationality.
Nash Equilibrium
To make this more concrete,recall what you may have heard about Nash equilibrium:
a player’s strategy doubles as her opponents’ beliefs about her strategy.
Thus,in a 2-player game,a Nash equilibrium is a speci cation of beliefs ( 1; 2)
for both players,with the property that if Player i’s belief assigns positive probability
to an action aj2Aj (j6= i),then the act faj is preferred by j to any other act,given
that j’s preferences are represented by the utility function uj,A ! R and the
3
probability measure i 2 (Ai) (note the indices!),In short,we say \aj is a best
reply to i".
Note,at rst sight,Nash equilibrium seems to say that players’ beliefs are required
to be \consistent with rationality",However,note that,since the rationality of an
act can only be assessed with respect to a given (utility function and) probability
measure over states of the world,the de nition really says that players’ beliefs are
required to be \consistent with rationality,given the equilibrium beliefs." We shall be
more speci c about this point in a subsequent lecture.
Also,note that this interpretation of Nash equilibrium has no behavioral content:
it is simply a restriction on beliefs,If we really wish to push this to the extreme,
we can say that,if players’ belief satis es the restrictions in the de nition of a Nash
equilibrium,then the players may choose an action that is a best reply to those beliefs.
Again,we will return to this point later in the course.
Zero-Sum games and the minmax solution
Game theorists were originally interested in a much simpler class of games,namely
two-player games in which interests were diametrically opposed:
De nition 3 A two-player simultaneous game ff1;2g;(Ai;ui)i2Ng is zero-sum i,
for all a2A,u1(a) +u2(a) = 0.
To put this in perspective,think about board games such as chess or checkers,or
war.
In the latter case,it appears that doing one’s best in the worst-case scenario might
be the \right" thing to do,I am told this is what they teach you in military academy,
anyway.
In a zero-sum game,the worst-case scenario for Player 1 is also the best scenario
for Player 2,and vice-versa,Thus,for Player 1 to assume that Player 2 is \out to
get her" is not inconceivable|after all,Player 2 has all the right incentives to do so.
This idea leads to the notion of maxmin and minmax strategies,Suppose rst that
both players can randomize|commit to spinning roulette wheels or something like
that,so as to choose strategies according to any pre-speci ed probability i2 (Ai).
We will get back to this later in the course,for now,let’s just assume that this is
possible; the reason why this is convenient will become clear momentarily,Again
using a conventional notation,let u1( 1; 2) =,P(a1;a2)2Au1(a1;a2) 11(a1) 12(a2) for
any ( 1; 2)2 (A1) (A2).
Consider rst a pair of mixed strategies 1i 2 (Ai),i = 1;2,such that
u1( 11; 12) = min
22 (A2)
max
12 (A1)
u1( 1; 2)
4
In words,u1( 11; 12) is the minimum payo that Player 1 can secure; equivalently,it
is the minimum payo to Player 1 when Player 2 attempts to damage her as much
as possible,while keeping into account the fact that Player 1 best-responds.
Note that since max f = minf,
u2( 11; 12) = u1( 11; 12) = max
22 (A2)
min
12 (A1)
u2( 1; 2)
i.e,( 11; 12) also yields Player 2 the maximum payo he can obtain if Player 1 chooses
her mixed strategy so as to hold Player 2’s payo down.
Such a pair of mixed strategies can always be found (why?),Similarly,one can
consider the symmetric problem for Player 2,and de ne a new pair ( 21; 22) such that
u2( 21; 22) = min
12 (A1)
max
22 (A2)
u2( 1; 2)
so u2( 21; 22) is the minimum payo that Player 2 can secure; as above,
u1( 21; 22) = max
12 (A1)
min
22 (A2)
u1( 1; 2)
the maximum payo that Player 1 can obtain if Player 2 attempts to hold Player 1’s
payo down.
It may be helpful to think about this as a \pseudo-dynamic" story,in order to
de ne ( 11; 12),one imagines that Player 2 chooses rst,and Player 1 moves next;
the latter best-responds to Player 2’s choice,and the former,anticipating 1’s best
response,attempts to minimize Player 1’s payo,On the other hand,to de ne
( 21; 22),one imagines that Player 1 chooses rst,and Player 2 moves next; the latter
observes 1’s choice and attempts to minimize 1’s payo,while the former,anticipating
this,attempts to maximize her own payo,[Of course there is a dual to this story,
with 1’s and 2’s roles inverted.]
It is natural to ask whether Player 1’s resulting payo under the two de nitions
is the same,The answer is a rmative:
Theorem 0.1 (a.k.a,\The minmax theorem"),there exists a pair ( 1; 2)2 (A1)
(A2) such that
u1( 1; 2) = max
12 (A1)
min
22 (A2)
u1( 1; 2) = min
22 (A2)
max
12 (A1)
u1( 1; 2)
The easiest proof of this theorem uses Linear Programming,Let ni be the cardi-
nality of Ai and number its elements from 1 to ni; de ne the n1 n2 matrix U by
letting Uk‘ = u1(ak1;a‘2),where ak1 and a‘2 are the k-th and ‘-th elements of A1 and A2,
respectively,Then Player 1’s (2’s) beliefs about Player 2’s choices may be represented
as nonegative vectors in 2 2Rn2 (resp,1 2Rn1) whose elements add up to one.
5
Consider the following problem:
min
2
u s.to U 2 + 1u 0; 10 2 = 1
which we can interpret as follows,Player 2 chooses 2 so that every strategy of Player
1 yields u or less; indeed,Player 2 attempts to make u as small as possible,Note
that u is unconstrained in sign.
The dual program is
max
1
v s.to 01U + 10v 0; 011 = 1
i.e,Player 1 chooses 1 so each of Player 2’s strategy yields at least v to Player 1
(think about it!),i.e,at most v to Player 2,Again,v is unconstrained.
Note that both programs are feasible (easy); also,both programs are bounded,
because,say,in the dual program,v cannot be larger than the largest entry in the
matrix U (which,if you think about it,is also obvious!) But then,by the Existence-
Duality theorem of LP,both programs have optimal solutions,the optimal values are
the same (so u = v),and the optimal solutions are complementary,In particular,
this means that 1(a1) > 0 implies u1(a1; 2) = u,and similarly for 2,Thus,only
actions which achieve the maximal payo u against 2 receive positive probability;
in other words,1 only assigns positive probabilities to best responses (and similarly
for 2),Hence,the optimal solutions of the dual LPs identify a Nash equilibrium; it
is then easy to see that any Nash equilibrium satis es the equality in Theorem 1 (see
Proposition 22.2 in OR if you don’t see this),and we are done.
6
