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Road Map
1.
2.
3.
4.
Examples
Sequential Rationality
Perfect Bayesian Nash Equilibrium
Economic Applications
1. Sequential Bargaining with incomplete
information
2. Reputation
An Example
Firm
Work
Hire
Shirk
High 0.7
Do not
hire
Nature
Hire
Low 0.3
(1, 2)
(0, 1)
(0, 0)
W
Work
Shirk
Do not
hire
(1, 1)
(-1, 2)
(0, 0)
Work
Hire
Shirk
High .7
Do not
hire
Nature
Low .3
(1, 2)
Hire
(0, 0)
W
Work
Shirk
Do not
hire
(0, 1)
(1, 1)
(-1, 2)
(0, 0)
(2,6)
2
L
(0,1)
R
(3,2)
L
(-1,3)
R
(1,5)
Beliefs
X
Beliefs of an agent at a given
1
(2,6)
information set is a
probability distribution on
T
B
the information set.
For each information set, we
1
must specify the beliefs of
2
the agent who moves at that
L
R
L
R
information set.
(0,1) (3,2)
(-1,3) (1,5)
Sequential Rationality
A player is said to be sequentially rational
iff, at each information set he is to move, he
maximizes his expected utility given his
beliefs at the information set (and given that
he is at the information set) even if this
information set is precluded by his own
strategy.
An Example
Firm
Work
Hire
Shirk
High 0.7
Do not
hire
Nature
Low 0.3
(1, 2)
Hire
(0, 0)
W
Work
Shirk
Do not
hire
(0, 1)
(1, 1)
(-1, 2)
(0, 0)
Another example
X
1
(2,6)
2
L
(0,1)
(3,2)
(-1,3)
(1,5)
Example
1
T
2
L
(0,10)
B
.9
.1
R
(3,2)
L
(-1,3)
R
(1,5)
Consistency
Definition: Given any (possibly mixed)
strategy profile s, an information set is said
to be on the path of play iff the
information set is reached with positive
probability if players stick to s.
Definition: Given any strategy profile s and
any information set I on the path of play of
s, a players beliefs at I is said to be
consistent with s iff the beliefs are derived
using the Bayes rule and s.
Example
1
T
2
L
(0,10)
R
(3,2)
L
(-1,3)
R
(1,5)
Example
1
E
2
T
2
0
0
3
L
R
1
2
1
3
3
3
R
0
1
2
0
1
1
Consistency
Given s and an information set I, even if I is
off the path of play, the beliefs must be
derived using the Bayes rule and s
whenever possible, e.g., if players tremble
with very small probability so that I is on
the path, the beliefs must be very close to
the ones derived using the Bayes rule and
s.
Example
1
E
2
T
2
0
0
3
L
R
1
2
1
3
3
3
R
0
1
2
0
1
1
Sequential Rationality
A strategy profile is said to be sequentially rational
iff, at each information set, the player who is to
move maximizes his expected utility
1. given his beliefs at the information set, and
2. given that the other players play according to
the strategy profile in the continuation game
(and given that he is at the information set) .
Nash
Bayesian Nash
Perfect Bayesian
Example
1
E
2
T
2
0
0
3
L
R
1
2
1
3
3
3
R
0
1
2
0
1
1
Beer Quiche
2
0
3
1
don
e
du
quiche
beer
{.1}
ts
beer {.9}
1
1
don
tw
el
du
1
0
du
el
quiche
don
t
don
3
0
0
0
du
el
0
1
2
1
2
0
3
1
don
el
du
1
0
du
el
t
don
.1
e
du
quiche
beer
{.1}
tw
quiche
1 d
on
t
ts
.9 beer {.9}
1
1
don
3
0
0
0
du
el
0
1
2
1
10
Example
2
(1,-5)
.9
.1
(4,4)
(3,3)
(5,2)
1
(-1,4)
(0,-5)
(-1,3)
(0,2)
Example solved
1 =7/9
=1/2
(1,-5)
=7/8
.9
.1
(4,4)
(3,3)
(5,2)
1
(-1,4)
(0,2)
(0,-5)
(-1,3)
11
Sequential Bargaining
1.
2.
3.
4.
S sets a price p 0;
B either
buys, yielding (p,v-p)
or does not, yielding (0,0).
p
Y
p
2-p
p
N
0
0
Y
p
1-p
N
0
0
12
Solution
US(p)
1. B buys iff v p;
1. If p 1, both types buy:
1
S gets p.
2. If 1 < p 2, only H-type
buys: S gets p.
3. If p > 2, no one buys.
2. S offers
1 if < ,
2 if > .
1. At t = 0, S sets a price
p0 0;
2. B either
3. At t = 1, S sets another
price p1 0;
4. B either
13
Solution, 2-period
1.
2.
3.
4.
5.
6.
7.
14
No pure-strategy equilibrium.
( p0 )
1
1
= ( p0 ) = 1 ( p0 ) =
.
( p0 ) + (1 ) 2
15
B buys at p iff v p;
S gets U(p) = p Pr(v p);
v in [0,a] => U(p) = p(a-p)/a;
p = a/2.
FOC:
2 p0
2p0
(1 / 2)
1
+
= 0 p0 =
1 / 2 2
2(1 3 / 4)
2
16