Lecture 4 & Revision Notes

Question 1

nash equilibrium = ?

Answer 1

given what the other player did, i’m happy with my choice

mutual best response

Question 2

prisoners dilemma = ?

Answer 2

when two players choose their dominant strategy that turns out to be pareto efficient

non cooperative game with no binding agreement

Question 3

what is the key idea on which a solution concept is based?

Answer 3

equilibrium

Question 4

equilibrium = ?

Answer 4

a state in which there’s nothing that will cause the state of the game to change

no incentive for players to deviate

Question 5

what is the nash equilibrium based on?

Answer 5

players’ best responses

Question 6

best response = ?

Answer 6

strategy that results in the highest payoff given the strategies of the other players

Question 7

black dot = ?

Answer 7

player’s favoured response

Question 8

circle = ?

Answer 8

mutual best response (nash equilibrium)

Question 9

dominant strategy = ?

Answer 9

a player’s best reaction regardless of what the other player might do

Question 10

what concept is widely used to evaluate economic outcomes?

Answer 10

pareto efficiency

Question 11

pareto efficiency = ?

Answer 11

an outcome is pareto efficient if there is no other feasible outcome that is superior to it

Question 12

pareto superiority = ?

Answer 12

an outcome that allows at least one player to be better off, without anyone being worse off

Question 13

how do we know if an outcome is pareto efficient?

Answer 13

if there’s no point to the north-east of it on the graph

Question 14

payoff dominant equilibrium = ?

Answer 14

occurs when there is no other equilibrium that is pareto-superior to it (e.g., 4,4 is payoff dominant equilibrium over 2,2)

Question 15

limitation of pareto efficiency = ?

Answer 15

it doesn’t tell us whether the game is fair

many pareto efficient outcomes mean there’s a conflict of interest over which pareto efficient outcome one would prefer

Question 16

assurance game = ?

Answer 16

a game with 2 nash equilibria

Question 17

invisible hand = ?

Answer 17

metaphor for how self-interested individuals operate through a system of mutual interdepence

Question 18

expected payoff. = ?

Answer 18

each payoff * the probability of it occurring

e.g., payoff 4, probability 1-P, expected payoff = 4(1-P)

Question 19

risk dominant strategy = ?

Answer 19

the strategy resulting in the highest payoff when both probabilities = 0.5 (equal probability)

Question 20

indifference probability (Pi) = ?

Answer 20

the point at which the players are indifferent and the expected payoffs are equal to eachother

Question 21

how is indifference probability (Pi) calculated?

Answer 21

put the two probabilities together and solve them

Question 22

what is indifference probability also known as?

Answer 22

tipping point

Question 23

tipping point = ?

Answer 23

the equilibrium at which everyone’s decision changes due to the expected payoff changing once it’s reached this point

Question 24

expected payoff = ?

Answer 24

the payoff to a strategy given the probability that the other player has for the strategy

expected payoff combines probabilities and payoffs

Question 25

exacerbate = ?

Answer 25

make worse

Question 26

credit markets = ?

Answer 26

markets in which one can attain a loan or incur debt

Question 27

contingency = ?

Answer 27

payoff to the outcome of a decision is contingent if something affecting the payoff may or may not happen

Question 28

sequential game = ?

Answer 28

game in which one moves after the other

Question 29

backwards induction = ?

Answer 29

procedure by which a player in a sequential game chooses a strategy by anticipating the strategies the other player will deploy in response

Question 30

normal form representation = ?

Answer 30

game shown by payoff matrix

Question 31

extensive form representation = ?

Answer 31

game shown by game tree

Question 32

can backwards induction be used to find nash equilibrium?

Answer 32

yes

Question 33

why do people buy insurance?

Answer 33

to avoid taking risks

Question 34

do people frequently accept unfavourable/favourable lotteries?

Answer 34

people frequently accept unfavourable lotteries

people frequently refuse favourable lotteries

Question 35

do people act as payoff maximisers?

Answer 35

no

hence why they insist on choosing unfavourable lotteries

Question 36

instead of maximising payoffs, what do people do?

Answer 36

maximise utility

Question 37

utility = ?

Answer 37

how different outcomes make us feel

this includes how the risk involved makes us feel (e.g., at ease, anxious etc.)

Question 38

what are the two classes of behaviour?

Answer 38

risk averse
risk netural

Question 39

risk averse = ?

Answer 39

being willing to pay to avoid exposure to risk

Question 40

risk neutral = ?

Answer 40

behaving as a payoff maximiser

Question 41

less wealthy people tend to be…

Answer 41

more risk averse

due to a lack of abundance

Question 42

wealthier people tend to be…

Answer 42

more risk neutral

due to abundance and freedom to take risk

Question 43

the vicious vs virtuous cycle has what impact on society?

Answer 43

increases inequalities between classes

the rich get richer and the poor stay poor

Question 44

what is the vicious vs virtuous cycle?

Answer 44

limited wealth = risk aversion = avoid risk = low returns (cycle)

substantial wealth = risk neutrality = take risks = high returns (cycle)