STRATEGY

AN INTRODUCTION TO GAME THEORY

JOEL WATSON
University of California, San Diego

Third Edition

W. W. NORTON & COMPANY

NEW YORK LONDON

CONTENTS*

PREFACE
1 INTRODUCTION
Noncooperative Game Theory
Contract and Cooperative Game Theory
The Meaning of "Game"

PART I: REPRESENTATIONS AND BASIC ASSUMPTIONS

2 THE EXTENSIVE FORM
Other Examples and Conventions
Guided Exercise
Exercises

xiii
1
3
4
5

7
9
15
17
18

3 STRATEGIES AND THE NORMAL FORM

22

Terminology and Notation for Strategies

The Normal Form
Classic Normal-Form Games
Interpretation of the Normal Form
Guided Exercise
Exercises

23
26
28
30
31
33

4 BELIEFS, MIXED STRATEGIES, AND EXPECTED PAYOFFS

Guided Exercise
Exercises

37
39
40

* Chapters in italics are applications chapters.

vii

viii

Contents
5 GENERAL ASSUMPTIONS AND METHODOLOGY
Rationality
Common Knowledge
Overview of Solution Concepts
The Issue of Realism

PART II: ANALYZING BEHAVIOR IN STATIC SETTINGS

6 DOMINANCE AND BEST RESPONSE
Dominance
The First Strategic Tension and the Prisoners' Dilemma
The Concept of Efficiency
Best Response
Dominance and Best Response Compared
Weak Dominance
Guided Exercise
Exercises
7 RATIONALIZABILITY AND ITERATED DOMINANCE
The Second Strategic Tension
Guided Exercise
Exercises
8 LOCATION, PARTNERSHIP, AND SOCIAL UNREST
A Location Game
A Partnership Game: Strategic Complementarities
Social Unrest
Guided Exercise
Exercises
9 NASH EQUILIBRIUM
Nash Equilibrium
Equilibrium of the Partnership Game
Coordination and Social Welfare

42
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46

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Contents
The Third Strategic Tension
Congruous Sets
Aside: Experimental Game Theory
Guided Exercise
Exercises
10 OLIGOPOLY, TARIFFS, CRIME, AND VOTING
Cournot Duopoly Model
Bertrand Duopoly Model
Tariff Setting by Two Countries
A Model of Crime and Police
The Median Voter Theorem
Strategic Voting
Guided Exercise
Exercises

104
104
106
107
108
113
113
115
117
118
118
120
123
124

11 MIXED-STRATEGY NASH EQUILIBRIUM

132

Randomization in Sports
Technical Notes
Example: Duopoly with Capacity Constraints
Guided Exercise
Exercises

135
136
137
140
140

12 STRICTLY COMPETITIVE GAMES AND

SECURITY STRATEGIES
Guided Exercise
Exercises
13 CONTRACT, LAW, AND ENFORCEMENT
IN STATIC SETTINGS
Complete Contracting in Discretionary Environments
Contracting with Court-Imposed Breach Remedies
Guided Exercise
Exercises

148
151
152

154
158
161
166
167

ix

Contents
PART III: ANALYZING BEHAVIOR IN DYNAMIC SETTINGS

173

14 DETAILS OF THE EXTENSIVE FORM

175

Recalling the Strategy Definition

Guided Exercise
Exercises
15 SEQUENTIAL RATIONALITY AND SUBGAME PERFECTION
Incredible Threats in the Stackelberg Duopoly Game
Sequential Rationality
Backward Induction
Subgame Perfection
The SPE of the Stackelberg Duopoly Game
Technical Notes
Conditional Dominance and Forward Induction
Guided Exercise
Exercises
16 TOPICS IN INDUSTRIAL ORGANIZATION
Advertising and Competition
A Model of Limit Capacity
Dynamic Monopoly
Price Guarantees as a Commitment to High Prices
Dynamic Price Competition with Capacity Constraints
Guided Exercise
Exercises
17 PARLOR GAMES
Guided Exercise

18 BARGAINING PROBLEMS
Bargaining: Value Creation and Division
An Abstract Representation of Bargaining Problems
An Example
The Standard Bargaining Solution
A Note About Legal Default Rules
Guided Exercise
Exercises

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209
21 3
21 5
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21 9
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Contents
19 ANALYSIS OF SIMPLE BARGAINING GAMES
Ultimatum Games: Power to the Proposer
Two-Period, Alternating-Offer Games: Power to the Patient
Infinite-Period, Alternating-Offer Game
Multilateral B argaining
Guided Exercise
Exercises
20 GAMES WITH JOINT DECISIONS;
NEGOTIATION EQUILIBRIUM

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250
2 51
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255

259

Joint Decisions
Negotiation Equilibrium
Example: Contracting for High-Powered Incentives
Guided Exercise
Exercises

260
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263
265
267

21 UNVERIFIABLE INVESTMENT, HOLD UP, OPTIONS,

AND OWNERSHIP

274

Hold-Up Example
Up-Front Contracting and Option Contracts
Asset Ownership
Guided Exercise
Exercises
22 REPEATED GAMES AND REPUTATION
A Two-Period Repeated Game
An Infinitely Repeated Game
The Equilibrium Payoff Set with Low Discounting
Guided Exercise
Exercises
23 COLLUSION, TRADE AGREEMENTS, AND GOODWILL
Dynamic Oligopoly and Collusion
Enforcing International Trade Agreements
Goodwill and Trading a Reputation
Guided Exercise
Exercises

275
278
281
283
285
291
292
297
302
306
307
311
311
313
314
317
318

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Contents
PART IV: INFORMATION

325

24 RANDOM EVENTS AND INCOMPLETE INFORMATION

327

Guided Exercise
Exercises
25 RISK AND INCENTIVES IN CONTRACTING
Risk Aversion
A Principal-Agent Game
Guided Exercise
Exercises
26 BAYESIAN NASH EQUILIBRIUM AND RATIONALIZABILITY
Guided Exercise
Exercises
27 LEMONS, AUCTIONS, AND INFORMATION AGGREGATION
Markets and Lemons
Auctions
Information Aggregation
Guided Exercise
Exercises
28 PERFECT BAYESIAN EQUILIBRIUM
Conditional Beliefs about Types
Sequential Rationality
Consistency of Beliefs
Equilibrium Definition
Guided Exercise
Exercises
29 JOB-MARKET SIGNALING AND REPUTATION
Jobs and School
Reputation and Incomplete Information
Guided Exercise
Exercises

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3g4
3gg
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395
3gg
4QQ

APPENDICES

407

INDEX

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