Analysis of Economic
Behaviour
Zvi Safra
Week 8-1 Game theory
Unit Overview
1. Dominant strategy equilibrium
2. Sequential elimination of dominated strategies
2
Honda and Toyota:
A Capacity Expansion Decision
The two giants face a simultaneous capacity decision problem:
(a) If both do nothing, their current yearly profits will stay at $18b.
(b) By investing in a new plant, each manufacturer expects to raise its
profits to $20b (at the expense of its competitor, whose profits will
be reduced to $15b).
(c) If both expand, profits will go down to $16b.
What should they do?
3
Capacity Expansion Game
Toyota
Build a new Do not Build
plant
Build a new 16,16 20,15
Honda plant
Do not Build 15,20 18,18
What is the likely outcome of this game? 4
Game Theory
Game Elements
Players: agents participating in the game (Toyota, Honda)
Strategies: Actions that each player may take under any possible
circumstance (Build, Don't build)
Outcomes: The various possible results of the game (four, each
represented by one cell of matrix)
Payoffs: The benefit that each player gets from each possible
outcome of the game (the profits entered in each cell of the matrix) 5
Game Theory
Information: A full specification of who knows what
when (full information)
Timing: Who can take what decision, when, and how
often the game is repeated (simultaneous, one-shot)
Solution concept of the game: "What is the likely
outcome"? (Dominant Strategy Equilibrium, Nash
Equilibrium)
6
Simultaneous Move Games
Games in which both players act at the same
time.
Equivalently, one player may take an action
before the other but the second cannot observe
the action taken by the first (and the first knows
it).
7
Prisoner's Dilemma
A game situation in which there is a tension between the collective interest
of all of the players and the self-interest of individual players is called a
Prisoner's Dilemma.
2
Confess Don't Confess
Confess -5,-5 0,-10
1 Don't Confess -10,0 -1,-1
8
Dominant Strategy & Equilibrium
A dominant strategy is a strategy that is strictly better than any
other strategy that a player might choose, no matter what strategy
the other player follows.
A dominant Strategy Equilibrium occurs when each player had a
dominant strategy and uses it.
In the prisoner’s dilemma, confessing is a dominant strategy for both
players and (Confess,Confess) is the dominant strategy equilibrium.
And, as is evident form that game, a dominant strategy equilibrium
may be jointly worse than another pair of strategies. 9
Dominant Strategy & Equilibrium
A dominant strategy is a strategy that is strictly better than any
other strategy that a player might choose, no matter what strategy
the other player follows.
A dominant Strategy Equilibrium occurs when each player had a
dominant strategy and uses it.
In the prisoner’s dilemma, confessing is a dominant strategy for both
players and (Confess,Confess) is the dominant strategy equilibrium.
And, as is evident form that game, a dominant strategy equilibrium
may be jointly worse than another pair of strategies. 10
Locating Dominant Strategies
To determine whether player 1 had a dominant strategy we look at his payoffs
at the left column (2 confesses) and underline the highest (-5). We then
repeat it with the right column (2 doesn’t confess) and underline the 0.
If all underlined payoff lie in the same row, then this strategy is dominant.
As can be seen below, Confess is a dominant strategy for player 1.
2
Confess Don't Confess
Confess -5,-5 0,-10
1 Don't Confess -10,0 -1,-1
11
Locating Dominant Strategies
Similarly, to determine whether player 2 had a dominant strategy we look at
his payoffs at the upper row (1 confesses) and underline the highest (-5). We
then repeat it with the bottom row (1 doesn’t confess) and underline the 0.
If all underlined payoff lie in the same column, then this strategy is dominant.
Therefore, Confess is a dominant strategy for player 2.
2
Confess Don't Confess
Confess -5,-5 0,-10
1 Don't Confess -10,0 -1,-1
12
Locating Dominant Strategy Equilibrium
Finally, to determine whether there exists a dominant strategy equilibrium, we
first need to verify that every player has a dominant strategy. If not, then
there is no such equilibrium. If they do, then a dominant strategy equilibrium
exists and it is given by the pair of strategies that are associated with the
unique cell in which both payoffs are underlined.
2
Confess Don't Confess
Confess -5,-5 0,-10
1 Don't Confess -10,0 -1,-1
13
Task 1
1. Find the dominant strategies of Toyota and Honda in the
capacity expansion game and identify the dominant strategy
equilibrium
2. Is this game of the prisoner’s dilemma type?
3. Construct another game in which payer 1 does not have a
dominant strategy while player 2 does. This game does not
have a dominant strategy equilibrium. However, can you
identify another reasonable outcome for it?
14
Dominant Strategy Equilibrium?
Most games do not possess a dominant strategy equilibrium. E.g.,
the this game where Honda does not have a dominant strategy.
Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
Hence, we try something else 15
Dominant Strategy Equilibrium?
Most games do not possess a dominant strategy equilibrium. E.g.,
the this game where Honda does not have a dominant strategy.
Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
Hence, we try something else 16
Dominated Strategy
A player has a dominated strategy when the player has another
strategy that gives it a strictly higher payoff no matter what the
other player does. Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
For Toyota, The strategy Don’t build is dominated (by Build).
17
Honda does not have a dominated strategy.
Dominated Strategy
A player has a dominated strategy when the player has another
strategy that gives it a strictly higher payoff no matter what the
other player does. Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
For Toyota, The strategy Don’t build is dominated (by Build).
18
Honda does not have a dominated strategy.
Dominated Strategy and an Equilibrium
Similarly to the understanding that players are likely to play
dominant strategies and hence, if they exist, a dominant
strategy equilibrium is very compelling, we can use dominated
strategies to try solving game.
More specifically, since dominated strategies are unlikely to be
played, these strategies can be eliminated from consideration in
more complex games.
So, we will eliminate dominated strategies, and then see if we
can eliminate more, and stop when we can no longer do it.
Hopefully we will arrive at one pair of strategies.
19
Elimination of Dominated Strategies
In this game Toyota will never choose the dominated strategy
Don’t build, and it can be eliminated. Being rational and
knowing that Toyota is rational, Honda understands it.
Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
20
Elimination of Dominated Strategies
In the reduced game, which consists of the left column, Build a
New Plant is dominated for Honda, and can be eliminated.
Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
21
Elimination of Dominated Strategies
Therefore, the outcome of the game is the pair (Don’t Build,
Build).
Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
22
Elimination of Dominated Strategies
Therefore, the outcome of the game is the pair (Don’t Build,
Build).
Toyota
Build a Don’t
New Plant Build
Honda Build a 12,4 20,3
New Plant
Don’t 15,6 18,5
Build
23
Elimination of Dominated Strategies
Only one strategy, Build Large for Honda, is dominated.
So we can eliminate it.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
24
Elimination of Dominated Strategies
Only one strategy, Build Large for Honda, is dominated.
So we can eliminate it.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
25
Elimination of Dominated Strategies
Only one strategy, Build Large for Honda, is dominated.
So we can eliminate it.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
26
Elimination of Dominated Strategies
Only one strategy, Build Large for Honda, is dominated.
So we can eliminate it.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
27
Elimination of Dominated Strategies
Only one strategy, Build Large for Honda, is dominated.
So we can eliminate it.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
28
Elimination of Dominated Strategies
In the reduced game, Build Large and Do Not Build become
dominated for Toyota.
So we can now eliminate these strategies.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
29
Elimination of Dominated Strategies
In the further reduced game, Do Not Build becomes dominated
for Honda.
So we can eliminate it now.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
30
Elimination of Dominated Strategies
The outcome of the game is the pair (Build Small, Build Small).
The process is sometimes called sequential elimination of
dominated strategies.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
31
Elimination of Dominated Strategies
The outcome of the game is the pair (Build Small, Build Small).
The process is sometimes called sequential elimination of
dominated strategies.
Toyota
Build Build Do Not
Large Small Build
Build Large 0,10 12,8 18,9
Honda Build Small 8,12 16,16 20,15
Do Not 9,18 15,20 18,18
Build
32
Elimination of Dominated Strategies?
The process increases the set of solvable games but is not satisfactory.
In many games we cannot even start the process of elimination of
dominated strategies and all outcomes survive it. E.g.:
Depositor 2
Withdraw Don't
Withdraw
Withdraw 25,25 50,0
Depositor 1
Don't 0,50 110,110
Withdraw
33
Elimination of Dominated Strategies?
The process increases the set of solvable games but is not satisfactory.
In many games we cannot even start the process of elimination of
dominated strategies and all outcomes survive it. E.g.:
Depositor 2
Withdraw Don't
Withdraw
Withdraw 25,25 50,0
Depositor 1
Don't 0,50 110,110
Withdraw
34
Elimination of Dominated Strategies?
The process increases the set of solvable games but, still, many
games do not possess a unique outcome that survives elimination of
dominated strategies. E.g.:
Depositor 2
Withdraw Don't
Withdraw
Withdraw 25,25 50,0
Depositor 1
Don't 0,50 110,110
Withdraw
35
Task 2
1. Construct a two player game, each with 3 strategies, such
that there are 4 stages of elimination and exactly one
dominated strategy is eliminated at every stage
2. Explain why both payoffs are underlined in the remaining
cell
3. A zero-sum game satisfies the property that, in each cell,
player 2’s payoff is the negative of that of player 1.
Construct a two player zero-sum game in which both players
have dominated strategies 36
Task 2
1. Construct a two player game, each with 3 strategies, such
that there are 4 stages of elimination and exactly one
dominated strategy is eliminated at every stage
2. Explain why both payoffs are underlined in the remaining
cell
3. A zero-sum game satisfies the property that, in each cell,
player 2’s payoff is the negative of that of player 1.
Construct a two player zero-sum game in which both players
have dominated strategies 37
