Game Theory. Strategic Form Games with Incomplete Information. Levent Koçkesen. Koç University. Levent Koçkesen (Koç University) Bayesian Games 1 / 15

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1 page.1 Game Theory Strategic Form Games with Incomplete Information Levent Koçkesen Koç University Levent Koçkesen (Koç University) Bayesian Games 1 / 15

2 page. Games with Incomplete Information Some players have incomplete information about some components of the game Firm does not know rival s cost Bidder does not know valuations of other bidders in an auction We could also say some players have private information What difference does it make? Suppose you make an offer to buy out a company If the value of the company is V it is worth 1.5V to you The seller accepts only if the offer is at least V If you know V what do you offer? You know only that V is uniformly distributed over [0,100]. What should you offer? Enter your name and your bid Click here for the EXCEL file Levent Koçkesen (Koç University) Bayesian Games / 15

3 page.3 Bayesian Games We will first look at incomplete information games where players move simultaneously Bayesian games Later on we will study dynamic games of incomplete information What is new in a Bayesian game? Each player has a type: summarizes a player s private information Type set for player i: Θi A generic type: θ i Set of type profiles: Θ = i N Θ i A generic type profile: θ = {θ 1,θ,...,θ n} Each player has beliefs about others types pi : Θ i (Θ i ) pi (θ i θ i ) Players payoffs depend on types ui : A Θ R ui (a θ) Different types of same player may play different strategies ai : Θ i A i αi : Θ i (A i ) Levent Koçkesen (Koç University) Bayesian Games 3 / 15

4 page.4 Bayesian Games Incomplete information can be anything about the game Payoff functions Actions available to others Beliefs of others; beliefs of others beliefs of others... Harsanyi showed that introducing types in payoffs is adequate Levent Koçkesen (Koç University) Bayesian Games 4 / 15

5 page.5 Bayesian Equilibrium Bayesian equilibrium is a collection of strategies (one for each type of each player) such that each type best responds given her beliefs about other players types and their strategies Also known as Bayesian Nash or Bayes Nash equilibrium Levent Koçkesen (Koç University) Bayesian Games 5 / 15

6 page.6 Bank Runs You (player 1) and another investor (player ) have a deposit of $100 each in a bank If the bank manager is a good investor you will each get $150 at the end of the year. If not you loose your money You can try to withdraw your money now but the bank has only $100 cash If only one tries to withdraw she gets $100 If both try to withdraw they each can get $50 You believe that the manager is good with probability q Player knows whether the manager is good or bad You and player simultaneously decide whether to withdraw or not Levent Koçkesen (Koç University) Bayesian Games 6 / 15

7 page.7 Bank Runs The payoffs can be summarized as follows W N W 50, , 0 N 0, , 150 Good q W N W 50, , 0 N 0,100 0,0 Bad (1 q) Two Possible Types of Bayesian Equilibria 1. Separating Equilibria: Each type plays a different strategy. Pooling Equilibria: Each type plays the same strategy How would you play if you were Player who knew the banker was bad? Player always withdraws in bad state Levent Koçkesen (Koç University) Bayesian Games 7 / 15

8 page.8 Separating Equilibria W N W 50, , 0 N 0, , 150 Good q W N W 50, , 0 N 0,100 0,0 Bad (1 q) 1. (Good: W, Bad: N) Not possible since W is a dominant strategy for Bad. (Good: N, Bad: W) Player 1 s expected payoffs Two possibilities W: q 100+(1 q) 50 N: q 150+(1 q) 0.1 q < 1/: Player 1 chooses W. But then player of Good type must play W, which contradicts our hypothesis that he plays N. q 1/: Player 1 chooses N. The best response of Player of Good type is N, which is the same as our hypothesis Separating Equilibrium q < 1/: No separating equilibrium q 1/: Player 1: N, Player : (Good: N, Bad: W) Levent Koçkesen (Koç University) Bayesian Games 8 / 15

9 page.9 Pooling Equilibria W N W 50, , 0 N 0, , 150 Good q W N W 50, , 0 N 0,100 0,0 Bad (1 q) 1. (Good: N, Bad: N) Not possible since W is a dominant strategy for Bad. (Good: W, Bad: W) Player 1 s expected payoffs W: q 50+(1 q) 50 N: q 0+(1 q) 0 Player 1 chooses W. Player of Good type s best response is W. Therefore, for any value of q the following is the unique Pooling Equilibrium Player 1: W, Player : (Good: W, Bad: W) If q < 1/ the only equilibrium is a bank run Levent Koçkesen (Koç University) Bayesian Games 9 / 15

10 page.10 Cournot Duopoly with Incomplete Information about Costs Two firms. They choose how much to produce q i R + Firm 1 has high cost: c H Firm has either low or high cost: c L or c H Firm 1 believes that Firm has low cost with probability µ [0,1] payoff function of player i with cost c j Strategies: u i (q 1,q,c j ) = (a (q 1 +q ))q i c j q i q 1 R + q : {c L,c H } R + Levent Koçkesen (Koç University) Bayesian Games 10 / 15

11 page.11 Complete Information Firm 1 Best response correspondence Firm Best response correspondences max q 1 (a (q 1 +q ))q 1 c H q 1 BR 1 (q ) = a q c H max q (a (q 1 +q ))q c j q BR (q 1,c L ) = a q 1 c L BR (q 1,c H ) = a q 1 c H Levent Koçkesen (Koç University) Bayesian Games 11 / 15

12 page.1 Complete Information Nash Equilibrium If Firm s cost is c H If Firm s cost is c L q 1 = q = a c H 3 q 1 = a c H (c H c L ) 3 q = a c H +(c H c L ) 3 Levent Koçkesen (Koç University) Bayesian Games 1 / 15

13 page.13 Incomplete Information Firm Best response correspondences max q (a (q 1 +q ))q c j q Firm 1 maximizes BR (q 1,c L ) = a q 1 c L BR (q 1,c H ) = a q 1 c H µ{[a (q 1 +q (c L ))]q 1 c H q 1 } Best response correspondence +(1 µ){[a (q 1 +q (c H ))]q 1 c H q 1 } BR 1 (q (c L ),q (c H )) = a [µq (c L )+(1 µ)q (c H )] c H Levent Koçkesen (Koç University) Bayesian Games 13 / 15

14 page.14 Bayesian Equilibrium q 1 = a c H µ(c H c L ) 3 q (c L ) = a c L +(c H c L ) 3 q (c H ) = a c H 3 +µ c H c L 6 Is information good or bad for Firm 1? Does Firm want Firm 1 to know its costs? (1 µ) c H c L 6 Levent Koçkesen (Koç University) Bayesian Games 14 / 15

15 page.15 Complete vs. Incomplete Information Complete Information Incomplete Information q q a c H BR1(q) a c H a c L a c H BR(q1,c L) q(c L) E[q] BR(q1,c H) q(c H) q1 q1 a c H a c H a c L q1 a c H a c H a c L Levent Koçkesen (Koç University) Bayesian Games 15 / 15