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Leonardo Felli
NAB.2.14
16 January 2014
Course Outline
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 2 / 28
Course Outline (contd)
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 3 / 28
Admin
I Office Hours:
I Monday 13:00-14:00, Thursday 11:00-12:30
I or by appointment (e-mail lfelli@econ.lse.ac.uk).
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 4 / 28
References:
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 5 / 28
Static Bayesian Games: Example 1.
1\2 L R
U 1, 1 0, 0
D 0, 0 6, 6
This game has two pure strategy Nash equilibria (U, L) and (D, R)
with payoffs respectively (1, 1) and (6, 6).
There also exists one mixed strategy Nash equilibrium (6/7, 6/7)
with payoffs (6/7, 6/7).
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 6 / 28
Static Bayesian Games: Example 1 (contd)
Assume now that player 2 has some small uncertainty when
casting her choice of strategy in the game.
9
With probability she thinks she is playing Game A:
10
1\2 L R
U1 1, 1 0, 0
D1 0, 0 6, 6
1
while with probability she thinks she is playing Game B:
10
1\2 L R
U2 1, 0 0, 10
D2 0, 0 6, 6
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 7 / 28
Static Bayesian Games: Example 1 (contd)
We assume that:
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 8 / 28
Static Bayesian Games: Example 1 (contd)
This is not a surprise since the payoffs to player 1 are the same in
both games.
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 9 / 28
Static Bayesian Games: Example 1 (contd)
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 10 / 28
Static Bayesian Games: Example 1 (contd)
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 13 / 28
Static Bayesian Games: Cournot Duopoly
c(q1 ) = c q1 .
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 14 / 28
Static Bayesian Games: Cournot Duopoly (contd)
We assume that:
Firm 1 does not know the variable cost of firm 2 but believes that:
1
I with probability the cost is high cH ,
2
1
I with probability the cost is low cL .
2
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 15 / 28
Static Bayesian Games: Cournot Duopoly (contd)
P(q1 + q2 ) = a (q1 + q2 )
where cH < a.
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 16 / 28
Static Bayesian Games: Cournot Duopoly (contd)
or h i
L2 (q1 , q2L ) = q2L a (q1 + q2L ) cL
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 17 / 28
Static Bayesian Games: Cournot Duopoly (contd)
For any given quantity chosen by firm 1, q1 , firm 2s best reply is,
depending on the value of the cost:
h i
max q2H a (q1 + q2H ) cH
q2H R+
or
1
q2H = (a q1 cH ) ,
2
and h i
max q2L a (q1 + q2L ) cL
q2L R+
or
1
q2L = (a q1 cL ) .
2
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 18 / 28
Static Bayesian Games: Cournot Duopoly (contd)
For any given quantity chosen by the two types of firm 2 q2H and
q2L , firm 1s best reply is:
1 h i 1 h i
max q1 a (q1 + q2H ) c + q1 a (q1 + q2L ) c
q1 R+ 2 2
or
1 1 H
1
L
q1 = a q2 c + a q2 c .
2 2 2
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 19 / 28
Static Bayesian Games: Cournot Duopoly (contd)
In other words the best reply of the two types of firm 2 and of firm
1 are:
1
q2H = (a q1 cH ) ,
2
1
q2L = (a q1 cL ) ,
2
1 1 1
q1 = a q2H c + a q2L c .
2 2 2
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 20 / 28
Static Bayesian Games: Cournot Duopoly (contd)
(a 2c + 12 cH + 12 cL )
q1 =
3
and
(a 2cH + c) 1
q2H = + (cH cL )
3 12
and
(a 2cL + c) 1
q2L = (cH cL )
3 12
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 21 / 28
Static Bayesian Games: Cournot Duopoly (contd)
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 22 / 28
Static Bayesian Games: Cournot Duopoly (contd)
These quantities are the solution to the following two problems:
h i
max q1H a (q1H + q2H ) c
q1H R+
and h i
max q1L a (q1L + q2L ) cL
q1L R+
or
1
q1L = a q2L c .
2
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 23 / 28
Static Bayesian Games: Cournot Duopoly (contd)
a q1H cH a q1L cL
H
q2 = , q2L = .
3 3
(a 2c + cH ) (a 2cH + c)
q1H = q2H =
3 3
and
(a 2c + cL ) (a 2cL + c)
q1L = q2L =
3 3
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 24 / 28
Static Bayesian Games: Cournot Duopoly (contd)
(a 2cH + c) 1
q2H = + (cH cL ) > q2H
3 12
and
(a 2cL + c) 1
q2L = (cH cL ) < q2L
3 12
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 25 / 28
Static Bayesian Game: Definition
A game of incomplete information is defined by:
I The set of players N, in the Cournot model
N = {1, 2}.
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 26 / 28
Static Bayesian Game: Definition (contd)
I The believes of every player on the types of the opponent: i
a conditional probability distribution on Ti , in the Cournot
model:
1 1
1 (cH ) = , 1 (cL ) = , 2 (c) = 1.
2 2
= {N, , Ai , Ti , i , ui }
Leonardo Felli (LSE) EC319 Economic Theory and Its Applications 16 January 2014 28 / 28