Chapter 7

Question 1

Game (game theory)

Answer 1

consist of a set of players, a set of rules and actions, and a set of payoff functions

Question 2

Normal form

Answer 2

A matrix where each cell corresponds to a combination of strategic choices by each player, with the payoff received by that strategy

Question 3

Dominant strategy

Answer 3

a dominant strategy yields a player the highest payoff regardless of the other players’ choices

Question 4

Prisoner’s dilemma

Answer 4

Depicts the conflict between individual incentives and joint incentives

Question 5

Dominated strategy

Answer 5

A dominated strategy yields a player a payoff that is lower than that of a different strategy, regardless of what the other players do.

Question 6

Rationality in game theory

Answer 6

It is not only important whether players are rational; it is also important whether player believe the other players are rational

Question 7

Absolute and relative payoff

Answer 7

In game theory, rationality means we assume that a player’s goal is to maximize their payoff

Question 8

Nash equilibrium

Answer 8

A pair of strategies constitutes a Nash equilibrium if no player can unilaterally change its strategy in a way that improves its payoff

Question 9

Best response

Answer 9

Mapping that indicates a player’s best strategy for each possible strategy of another player.

Question 10

Focal point

Answer 10

A solution that people tend to choose by default in the absence of communication

Question 11

Games in extensive form

Answer 11

Games which are represented by trees (sequential)

Question 12

Backward induction

Answer 12

The process of reasoning backwards in time, from the end of a problem or situation, to determine a sequence of optimal actions

Question 13

Subgame-perfect equilibria

Answer 13

A refinement of a Nash equilibrium used in dynamic games

Question 14

Short-run and long-run

Answer 14

The sequence of moves plays an important role when the game under consideration depicts a long-term situation where players choose both long-run and short-run variables.

Long-term there is a strategy, short-term there is an action

Question 15

Credible commitment

Answer 15

A credible commitment may have significant strategic value. Introducing credible commitment can raise the payoff, which is the value of the commitment.

Question 16

Retaliation

Answer 16

Situation whereby a player changes its action in response to a rival’s action. This cannot be achieved in a static, simultaneous-move game.

Question 17

One-shot game

Answer 17

A game in which each player chooses one action only once - also referred to as stage game

Question 18

Repeated game

Answer 18

Defined by a one-shot game which is repeated a number of times

Games ends with probability: 1- delta

Question 19

Payoff in repeated game

Answer 19

Total expected payoff is obtained by multiplying payoffs by delta, the probability that the game will continue.

Nash equilibrium if V => V’

Question 20

One-shot game vs repeated game (equilibrium)

Answer 20

Because players can react to other players’ past actions, repeated games allow for equilibrium outcomes that would not be an equilibrium in the corresponding one-shot game.

Question 21

Relational contracts

Answer 21

High-value transactions which are based on unwritten contracts

Question 22

Different interpretations of delta (2)

Answer 22

The game will end infinite time, but it is unknown when. The game ends with probability of 1 - delta.

The game lasts for an infinite number of periods and the players discount future payoffs with the discount factor delta

Question 23

Nature (player in game theory)

Answer 23

It has no strategic motives, and its actions are limited to choosing different branches of a game tree according to predetermined probabilities.

Added in order to model games where there is uncertainty and asymmetric information

Question 24

(un)informed player moves first

Answer 24

If an uninformed player has to move first: adverse selection

If an informed player has to move first: signaling game