01.16.01 Lecture Notes in Game Theory 1

Game Theory Applications: Lecture 2

Galina Albert Schwartz Department of Finance University of Michigan Business School

01.16.01 Lecture Notes in Game Theory 2

How to find me:

My office: D3270A (Davidson Hall) My e-mail: galka@umich.eduMy office hours: Mon., 10am - 12pm & Th., 1pm - 3pm,or by appointment

01.16.01 Lecture Notes in Game Theory 3

Lecture 2 : Terminology & Examples of Basic Games

Dixit, Chapters 1 & 2 (mostly 2) Definitions

– strategy– outcome– equilibrium– payoff – expectations– rationality

01.16.01 Lecture Notes in Game Theory 4

The Major Definition Dixit, p. 29 second paragraph from

the bottom Our definition of the rules of the game

– list of players– strategies available to each of them– payoffs of each player for all possible

combinations of all player strategies– each player is a rational maximizer

01.16.01 Lecture Notes in Game Theory 5

Definitions: Strategy is a set of the choices

available for the players, (Dixit, p. 25) Payoff is a number associated with

each possible outcome of the game (Dixit, p. 26) (and Expected payoff)

Equilibrium - each players strategy is a best response to the strategies of others, p. 30

01.16.01 Lecture Notes in Game Theory 6

What Do We Assume about the Game?

Rationality implies:– consistency in the ranking of the

payoffs– ability to calculate what is in his best

interest Common knowledge of the rules

of the game

01.16.01 Lecture Notes in Game Theory 7

What is Rationality? Rationality does not imply:

– the same values for everyone– impossibility of altruism[could be

incorporated in payoff]– short-term rationality [irrational from

immediate perspective may be valuable as a long-term strategy] »example: prices: introductory prices &

predatory prices. Interaction between the two

01.16.01 Lecture Notes in Game Theory 8

Classification of the Games

Dixit, Chapters 1 & 2 (mostly 2)– constant-sum games zero-sum games – bargaining games– brinkmanship– sequential moves games– simultaneous moves games– cooperative games (we will not address) [i.e. games with a possibility of

enforceable joint-action agreements]

01.16.01 Lecture Notes in Game Theory 9

Classification of the Games (cont.)

Dixit, Chapters 1 & 2 (mostly 2)– non-cooperative games– non-repeated games (one-shot games)– repeated games– repeated but with different opponents– dynamic games (evolutionary games) [or, are the rules fixed or permit

manipulation?]

01.16.01 Lecture Notes in Game Theory 10

What is more important: How or Why?

How (cases) Why (theory) Apply game theory to

– explain– predict– advise (prescribe)

Why is needed to advice (prescribe)

01.16.01 Lecture Notes in Game Theory 11

Lewis, Chapter 2: Never Mention Money. Game 1

Never Mention Money: Does it makes any sense?– Yes, it does. [The required answer

actually makes perfect sense.] Emotions matter! I.e.:

– the people [excitement by the high-caliber people]

– the challenge– the thrill of the deal

01.16.01 Lecture Notes in Game Theory 12

Lewis, Chapter 2: Never Mention Money. Game 2

Why analysts’ job has super-long hours? – from a production point: inefficient– Prisoners dilemma? [A small part of the

explanation] [But a cutthroat business competition is

a Prisoner’s dilemma]– Major purpose - to deter cheats [time

constraint on physical implementation , and design of the cheating mechanism]

01.16.01 Lecture Notes in Game Theory 13

Lewis, Chapter 2: Never Mention Money. Game 3

Interviewing with Solomon Brothers.– Why intellect is not checked sometimes?

» It is implied to be sufficient

– Why education (the knowledge) is irrelevant, but still is required?»signals interests»signals ability»majoring in economics: permit direct

comparison

01.16.01 Lecture Notes in Game Theory 14

Lewis, Chapter 2: Never Mention Money. Game 3 (cont)

– Why to intimidate?»Speed (and quality) or responses in

unfamiliar situation are tested– Why no explicit offer?

»Nobody could turn it down» Importantly: impossible to state that you

turned Solomon down– No explicit salary offer. To underpay?

»No, to screen. A quest for the able ones (who do not fear the risk & confident in abilities)

01.16.01 Lecture Notes in Game Theory 15

Summary of Today Definition of the Game p. 29 The definition of Nash Equilibrium,

p. 30 Lewis, Chapter 2: examples of the

games

01.16.01 Lecture Notes in Game Theory 16

To Do: your preparation to 01.18.01

Read: Dixit, chapter 2 Read: Lewis, chapters 2 & 3 Next time: we will explain what is the

absolutely necessary component of the Greenspan’s strategy [and any other Central Banker’s strategy]

Please, prepare your guesses of the ’absolutely necessary component’