Transcript Bayesian Games

Bayesian Games
Microeconomics C
Amine Ouazad
Who am I
• Assistant prof. at INSEAD since 2008.
• Teaching Prices and Markets in the MBA
program, Econometrics A, B,
Microeconometrics, in the PhD program.
• Research:
– Applied empirical work on Urban Economics.
– Economics of Discrimination.
– Banking/Competition.
– Econometric Forecasts.
• I tend to cold call.
Goals of my Micro C classes
1. Economics and psychology have a large number
of common interests, but use different
toolboxes.
– Subjective perceptions, gender, culture.
– Economics and individual rationality.
– Formation of perceptions using Bayes’ framework.
1. Economics and strategy use very similar tools
and have a large number of common interests:
– Strategic interactions.
– Strategic interactions with imperfect information.
Two maths/econ tools for today
• Bayes’ formula(s):
– P(A)= P(A|B) P(B) + P(A|not B)P(not B)
– E(A)= E(A|B) P(B) + E(A|not B) P(not B)
• Risk neutrality, risk aversion:
– Do you prefer : 0 with 50% chance, 10 euros with 50%
chance or 5 euros with certainty?
– Risk neutral: indifferent between the two choices.
What matters for your choice is the expected payoff.
• Assumption throughout: players are risk neutral.
Outline
1. Recap on games, strategies,
and Nash equilibria.
2. Guess a number
3. Prisoners’ Dilemma
1.
2.
Perfect information
Uncertainty
4. Entry Game.
1.
2.
3.
4.
Basic Entry Game
With Uncertainty
Multiple Periods
Multiple Periods with Uncertainty
5. Recommended Books and Papers.
Remember: “Economists do it with models”
1. Recap on games, strategies, and
Nash Equilibria
• Key concepts: Players, Strategies, Payoffs.
• Simultaneous-move and sequential games.
• Sequential games: Nash Equilibrium by backward
induction.
• Simultaneous move game: 1. Nash Equilibrium by
finding mutual best responses. 2. Nash
equilibrium by finding strategies where no player
has an incentive to deviate unilaterally.
• Typical games:
– The prisoner’s dilemma.
– The battle of the sexes.
2. Guess a number
• Each person gives me a number between 0
and 100.
• The person who is closest to 2/3 of the
average gets a bottle of champagne.
• Number?
• What’s the reasoning?
• Typical outcomes?
2. Guess a number
The Bayesian Approach
• Assumption of perfect rationality is not consistent with the empirical
observations…
• Assume that players are of one of two types: either rational or random.
• The random players choose a number between 0 and 100 randomly.
• What should be the choice of the rational players?
• Note first that all rational players will choose the same number.
– Call this number x.
• Then we use Bayes’ formula.
– E(numbers) = E(numbers|rational players). P(rational players) + E(numbers|random
players).P(random player).
• Solution?
2. Guess a number
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Another approach to the problem.
“Iterated Elimination of Dominated Strategies”
Anyone playing a number between 67 and 100?
Anyone playing a number between 44 and 100?
Etc…
What is the number left?
But is everybody thinking so deeply?
(Nagel, 2002)
• Can we explain our empirical results in the MBA
classroom? What is students’ depth of thinking?
3. Prisoners’ Dilemma
• Example #1: Prisoners.
• Example #2: Price Competition.
2. Prisoners’ Dilemma
Example #1: Prisoners.
Roadmap
• Players, Strategies, and Payoffs.
• Write the payoff matrix.
• Are there dominant strategies?
• What is the Nash equilibrium?
• Where is the uncertainty?
• Write the payoff matrix(ces) with uncertainty.
• What is one Bayesian Nash equilibrium?
Prisoners
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•
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Confess/Not Confess
Simultaneous or sequential move game?
Dominant strategy? Weakly dominant strategy?
Nash equilibrium?
Jim/John
Not Confess
Confess
Not Confess
-2,-2
-8,0
Confess
0,-8
-5,-5
Prisoners
• The psychology of the game is essential.
• How does that affect the game?
Players’ types?
Players’ beliefs?
Jim/John
Not Confess
Confess
Not Confess
-2,-2
-8,0
Confess
0,-8
-5,-5
The psychological cost of confessing. If both players have a cost of confessing:
Jim/John
Not Confess
Confess
Not Confess
-2,-2
-8,0-c
Confess
0-c,-8
-5-c,-5-c
Golden Balls
Bayesian game:
Types, Beliefs, Strategies, Payoffs.
• Type is either {high cost c,low cost c}.
• Beliefs about the other player’s type are
represented by the subjective probability of
being of a high cost c of deviation/low cost.
• Simultaneous move game.
• Strategy: one action for each type.
• Payoffs: the payoff matrix for each pair of
types of players.
Bayesian Nash equilibrium
• is a strategy for each player, for each type, such that:
each player’s strategy is a best response to the other
player’s strategy
given
(a) his beliefs about the other player’s type and
(b) given the other player’s strategy for each type.
Bayesian Nash equilibrium
• We check that the following is a Bayesian Nash equilibrium:
– The high cost of deviation player does not confess.
– The low cost of deviation player confesses.
Checking this is an equilibrium:
• What is Jim’s best response?
– when he is of a high cost of confessing?
– when he is of a low cost of confessing?
… and when he believes that John is of a high cost with probability p.
… and when he assumes the above strategy (blue box) for John.
• Same question for John.
What fraction of games see both players cooperating?
Key concepts for this session (1/2)
• Simultaneous move games with imperfect
information.
• Players, Strategies, Payoffs.
• Beliefs, Types.
• Bayesian Nash Equilibrium.
3. Prisoners’ Dilemma
Example #2: Price competition.
• Airline pricing.
• Capacity Constraints?
• Players, Strategies, Payoffs.
• Write the Payoff Matrix.
• Are there dominant strategies?
• What is the Nash equilibrium?
• Where could be the uncertainty?
Price competition:
Tiger vs. Singapore Airlines
Flight at 10am on January 23rd
At 4pm the previous day… what should the Tiger and Singapore Airlines pricing people display
on the website? Two pricing points: $200 or $150.
Demand for seats: 40.
Marginal cost: $20 per seat.
Airline with the lowest price sells 40 seats.
If equal prices: customers indifferent between the two airlines.
Singapore
Airlines/Tiger
High price
Low price
High price
$3600,$3600
0,$5200
Low price
$5200,0
$2600,$2600
What if… Tiger does not have 40
empty seats?
• If Tiger only has 10 seats unbooked…
• When both set the same price, Singapore sells 30 seats, Tiger
sells 10 seats. (Total demand is 40).
Singapore
Airlines/Tiger
High price
Low price
High price
$5400,$1800
$5400,$1300
Low price
$5200,$0
$3900,$1300
Singapore Airlines does not know for
sure Tiger’s remaining capacity
• Tiger can be of one of two types. Either Unconstrained,
or Constrained
• Prior p=P(Constrained).
• Singapore’s capacity is common knowledge.
• Check whether the following is a Bayesian Nash
equilibrium:
– The unconstrained Tiger Airways deviates, the constrained
Tiger Airways does not deviate; Singapore Airlines does
not deviate.
– “deviate”=“sets a low price.”
– Under what constraint on p is this a Bayesian Nash
equilibrium?
4. Entry Game
• Example #1: The flatmate.
• Example #2: Apple vs Samsung.
Roadmap for this section
• Write the sequential game.
• What is the subgame perfect Nash equilibrium?
• Where is the uncertainty?
• Consider the game with no uncertainty, repeated multiple
times. What is the subgame perfect Nash equilibrium?
• What about uncertainty with multiple periods?
Takeaways?
Apple vs Samsung
• Rivals: Handsets are (imperfect) substitutes in
the eyes of consumers.
• Entrant and incumbent?
• Fighting against the entrant?
• Cost of fighting?
• Benefit of fighting?
"I'm willing to go
thermonuclear war on this“
-- Steve Jobs
• “A little less Samsung in Apple sourcing.”
Beyondbrics, Financial Times, Sep 10, 2012.
• “Trade Judge backs Apple in Samsung fight.”
Oct 24, Financial Times.
• “Tension on Display: Samsung may end
Dwindling LCD Panel Deal with Apple.” Wall
Street Journal, Oct 22, 2012.
• “Samsung, Apple, amass 4G Patents for
Battle,” Wall Street Journal, Sep 12, 2012.
Entry deterrence
• Predatory pricing.
– Walmart.
– But
• Increases in output (commodity markets,
close substitutes).
• Lawsuits.
– Apple vs Samsung.
Entry Game, “Soft” Incumbent
Entrant
Stay out
Enter
Incumbent
(0,10)
Fight
(-5,4)
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•
•
Accommodate
(5,5)
Discuss the payoffs. Give at least 2 examples of market competition to which this sequential game may apply.
Notice the order of the payoffs. The first mover comes first.
What is the subgame perfect Nash equilibrium?
Entry Game, “Tough” Incumbent
Entrant
Stay out
Enter
Incumbent
(0,10)
Fight
(-5,6)
•
Accommodate
(5,5)
What is the subgame perfect Nash equilibrium? Such an equilibrium justifies
talking about a “tough” incumbent.
What if we don’t know the
incumbent’s type?
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Prior about the incumbent.
We represent this prior with a probability p: The entrant believes that the incumbent is tough with probability p.\
Fill in the payoffs below.
When does the entrant choose to enter? When does he choose to stay out?
Entrant
Stay out
Enter
Incumbent
( , )
Fight
(
,
Accommodate
)
(
,
)
Playing the entry game twice…
knowing that the incumbent is soft.
Entrant
Entrant
Stay out
Stay out
Enter
Enter
Incumbent
Incumbent
(0,10)
(0,10)
Fight
(-5,4)
Fight
Accommodate
(5,5)
(5,5)
(-5,4)
Round 2
Round 1
•
Would the incumbent fight?
Accommodate
Playing the entry game twice…
knowing that the incumbent is tough.
Entrant
Entrant
Stay out
Stay out
Enter
Enter
Incumbent
Incumbent
(0,10)
(0,10)
Fight
(-5,6)
Fight
Accommodate
(5,5)
(5,5)
(-5,6)
Round 2
Round 1
•
Would the incumbent fight?
Accommodate
Playing the entry game twice…
not knowing the incumbent’s type.
Entrant 1
Stay out
Entrant 2
Stay out
Enter
Enter
Incumbent
Incumbent
( , )
( , )
Fight
Accommodate
( , )
( , )
Round 1
•
Fight
Accommodate
( , )
( , )
Round 2
• Would the incumbent fight?
What information does the fight (or not fighting) give?
Reputation management
• Fighting tells potential entrants that you are
either tough or a soft guy trying to build his
reputation.
• Accommodating tells potential entrants that you
are soft with certainty.
• ➭One discordant piece of information is enough
to destroy one’s reputation.
– “it takes a lifetime to build a reputation and one
second to destroy it.” Warren Buffett and many other
“wise” guys.
Playing the entry game twice…
not knowing the incumbent’s type.
• The tough incumbent fights in every period.
• The soft incumbent fights if…
– The cost of fighting is smaller than the benefits of
building a reputation.
– What is this cost of fighting?
– What is the benefit of having a reputation?
• With a discount factor?
– What is the meaning of the discount factor?
Perfect Bayesian Nash Equilibrium
• Pooling equilibrium:
All types play the same strategy.
Observing the actions does not
bring information on the types.
– Tough and soft incumbents fight in the first period.
– Soft incumbents find it rational to fight in the first
period.
Different types play different
• Separating equilibrium:
strategies.
Observing the actions gives
information about types.
– Tough incumbents fight.
– Soft incumbents accommodate.
– Soft incumbents do not find it rational to fight in the
first period.
Playing the Entry game n times… not
knowing the incumbent’s type.
• When there are k periods (think years, quarters),
the reputational benefits are multiplied by k (if
discount factor is 1), so the earlier the entry, the
larger the reputational benefits of fighting.
• Confident of being present in the market for a
large number of years/quarters?
The longer the time horizon, the more important
reputation is.
• Solve this with 3 periods.
Key concepts for this session (2/2)
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Sequential games with imperfect information.
Players, Strategies, Payoffs.
Beliefs, Types.
Perfect Bayesian equilibrium.
In a Perfect Bayesian equilibrium, players “update” their beliefs according to
Bayes rule.
5. Recommended Books and Chapters
Strategic Thinking
• Dixit and Nalebuff’s
“The Art of Strategy”
and “Thinking Strategically.”
• David Besanko’s “Economics of Strategy.”
More than Strategic Thinking
• “The Armchair Economist.”
• “The Undercover Economist.”
Key concepts for this session (1/2)
• Simultaneous move games with imperfect
information.
• Players, Strategies, Payoffs.
• Beliefs, Types.
• Bayesian Nash Equilibrium.
Make sure you know the meaning of these concepts.
Key concepts for this session (2/2)
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•
•
•
Sequential games with imperfect information.
Players, Strategies, Payoffs.
Beliefs, Types.
Perfect Bayesian equilibrium.
Make sure you know the meaning of these concepts.