Lecture 1 - Some Games

Watson: 1,2
Econ 106G Spring 2014
Some Games
Government Shutdown and the Debt Ceiling
On September 30th, 2013, the US government shutdown because Republicans in the
House tied the passing of a budget to a defunding of Obamacare
This shutdown is generally perceived as being very harmful, although some Republicans
seem to favor it
Additionally, the government needs to raise its debt ceiling by October 17th, 2013 to
avoid a default
Between October 1st and 17th, Republicans propose partial solutions to the shut-
down that exempt favored parts of the government, such as Veteran Aairs.
The Senate Democrats rejects these piece-meal oers and keeps demanding an overall
budget.
Over the course of the shutdown, public opinion turns against the Republicans.
On October 16th, the Republicans agree to a budget with minimal concessions.
Pre-Existing Health Conditions
Blue Cross is selling health insurance to an economics professor and can choose between
a high, medium and low price
The professor can be healthy or sick and he can decide whether or not to buy the
insurance
If the professor does not know whether he is healthy or sick he prefers to buy the
insurance if the price is medium or low, but not if it is high
If Blue Cross knows this, it chooses the medium price and the professor buys the
insurance
If the professor has a pre-existing condition and knows whether he is healthy or sick,
the situation changes
If he is healthy, he only buys the insurance if the price is low
If he is sick, he buys the insurance at any price
Now the insurance faces a problem if it charges the medium price, because the professor
will only buy it if he is sick
1
This phenomenon is called adverse selection
Assuming that the low price is too low to cover for the risk, the insurance chooses the
high price and the professor purchases the insurance only if he is sick
If the insurance could oer dierent policies for professors with/without pre-existing
conditions, it would oer a low price if the professor is healthy, and a high price if he
is sick.
Crying it out
A two-year old girl wants to take her doll with herself into the bathtub
Her father is concerned that the doll might fall apart either in the bathtub, or later in
the dryer
However, he is willing to concede if having her doll with her is very important to his
daughter
The girl can cry as long as she chooses to get her way
The father can force his way as long as he is willing to
The longer the girl cries, the more her father becomes convinced that having the doll
is very important
The longer the father holds out, the more the girl becomes convinced that the father
will not concede this time
The Sex-Ratio
Why is there a roughly even number of men and women on the world?
Darwins theory of evolution by mutation and selection predicts that genetic traits that
enhance the tness of an individuum will spread through the population
Assume that the ratio of women to men
w
m
was not equal to 1 but, say,
w
m
= 0:2, so
there are ve men for each woman
Every woman has N = 12 kids, 2 daughters and 10 sons
Every man has a chance of
1
5
of mating with a woman and thus in expectation has 0:4
daughters and 2 sons
Note that women are much more productive than men
So, every woman will in expectation have 8 granddaughters and 40 grandsons
She has 12 children, 2 daughters and 10 sons
Each of the 2 daughters has 2 daughters and 10 sons for a total of 4 granddaughters
and 20 grandsons
2
Each of the 10 sons has 0:2 2 = 0:4 daughters and 0:2 10 = 2 sons for a total
of 4 granddaughters and 20 grandsons
Consider a dominant mutation that leads to an equal number of 6 girls and 6 boys
She still has 12 children, 6 daughters and 6 sons
Each of the 6 daughters has 6 daughters and 6 sons
Each of the 6 sons has 0:2 6 = 1:2 daughters and 0:2 6 = 1:2 sons
Thus, the total number of grandchildren is 6 6 + 6 1:2 = 36 + 7:2 = 43:2
granddaughters and 43:2 grandsons
...
Thus, after only two generations the mutation is leading to strictly more granddaugh-
ters and grandsons
Eventually the mutation will spread over the entire population
What is Game Theory?
Denition 1 Game theory is a tool to analyze interaction among a group of rational, strate-
gic agents.
A more descriptive term would be "Interactive Decision Theory".
Let us elaborate on the key terms in this denition:
Interaction in a Group: In each example there are at least two players and each
players payo from the game depends not only on her own action but also on the
other players actions. However, the presence of multiple players in a problem does
not make it a game. Consider the situation of going to a restaurant with a group of
friends. If everybody orders and pays for their own food, this is just a collection of
decision problems. If, however, the bill is split evenly within the group, the decisions
become interactive and we can use game theory to study the situation.
Rational, strategic Agents: Players are assumed to have well-dened payos over
the outcomes of the game and try to secure themselves the highest payo. In choosing
ones own action a player tries to guess the other players actions and choose an action
that secures herself a high payo given this guess. This implicitly assumes that players
understand the game and know that the others also understand the game.
Tool to analyze: Game theory cannot tell us whether it is a good idea for president
Obama to allow insurances to discriminate based on pre-existing conditions, or for
a father to let his daughter have her doll. Rather, game theory provides us with a
rigorous language to analyze the strategic considerations faced by these people. If our
game-theoretic models are suciently close to the real situation that is being modeled,
our game-theoretic results can be useful in both positively, by predicting how people
will act, and normatively, by indicating how we can improve our actions.
3
(Brief) History of Game Theory
1838 Cournot analyzed oligopolistic quantity competition applying a version of Nash
Equilibrium
1944 John von Neumann and Oskar Morgenstern: Theory of Games and Economic
Behavior focused on two-player zero-sum games
1950 John Nash develops the Nash equilibrium
1970s - present: Application of game theoretic concepts to various areas of economics
1994 Nobel prize to Nash, Harsanyi, Selten
2005 Nobel prize to Aumann and Schelling
2007 Nobel prize to Hurwicz, Maskin and Myerson
2012 Nobel prize to Roth and Shapley
Economic Applications
Game theory has pervasive implications in several areas of economics
Industrial Organization: Price setting; Quantity setting; Product Choice; Entry into
an Industry; Exit from an Industry
Trade: Setting of Taris and Quotas
Labor: Eort choice of worker; Promotion tournaments
Public Finance: Tragedy of the commons
Political Economy: Choice of optimal election platform
Prisoners Dilemma
Two prisoners are charged of a serious crime. If they both Cooperate and do not confess,
they will be released after one year of investigation. If they both Defect and confess, they
will both be sent to prison for three years. If only one of them Defects but the other one
Cooperates, the defector gets out of prison for free, while the cooperator receives a sentence
of ve years.
Every prisoner wants to mimize her own time in prison.
2
C D
1 C 1 , 1 5 , 0
D 0 , 5 3 , 3
4
In a variation of the Prisoners Dilemma, prisoner 2 is scrupulous and prefers to cooperate
with prisoner 1, as long as 1 cooperates as well. Thus the payo matrix is given by
2
C D
1 C 1 , 1 5 , 2
D 0 , 5 3 , 3
Think about for next class:
Would you cooperate or defect in the prisoners dilemma?
Would you cooperate or defect in the variation of the prisoners dilemma if you were
prisoner 1? If you were prisoner 2?
5
Government Shutdown and the Debt Ceiling
S
Concede
No
H
No
Concede
S
Concede
No
H
No
Concede
October 1
st
October 17
th
Prof. Blue
Cross
High
buy
no
Pre-Existing Health Conditions 1
Low
Medium
buy
no
buy
no
Prof. Blue
Cross
High
buy
no
Pre-Existing Health Conditions 2
Low
Medium
buy
no
buy
no
High
buy
no
Low
Medium
buy
no
buy
no
Healthy
Sick
Chance
6
Prof. Blue
Cross
High
buy
no
Pre-Existing Health Conditions 3
Low
Medium
buy
no
buy
no
High
buy
no
Low
Medium
buy
no
buy
no
Healthy
Sick
Chance
F
G
Crying it out
cry
accept
Hold out
concede
F
G
cry
accept
Hold out
concede
F
G
cry
accept
Hold out
concede
F
G
cry
accept
Hold out
concede
Real
problem
Hissy fit
N
7