Lecture 19 - Subgame perfect equilibrium: matchmaking and strategic investments

author: Benjamin Polak, Department of Economics, Yale University
recorded by: Yale University
published: Nov. 15, 2010,   recorded: September 2007,   views: 3337
released under terms of: Creative Commons Attribution No Derivatives (CC-BY-ND)
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Description

We analyze three games using our new solution concept, subgame perfect equilibrium (SPE). The first game involves players' trusting that others will not make mistakes. It has three Nash equilibria but only one is consistent with backward induction. We show the other two Nash equilibria are not subgame perfect: each fails to induce Nash in a subgame. The second game involves a matchmaker sending a couple on a date. There are three Nash equilibria in the dating subgame. We construct three corresponding subgame perfect equilibria of the whole game by rolling back each of the equilibrium payoffs from the subgame. Finally, we analyze a game in which a firm has to decide whether to invest in a machine that will reduce its costs of production. We learn that the strategic effects of this decision - its effect on the choices of other competing firms - can be large, and if we ignore them we will make mistakes.

Reading assignment:

Strategies and Games: Theory And Practice. (Dutta): Chapter 13

Strategy: An Introduction to Game Theory. (Watson): Chapter 16

Resources:

Blackboard Notes Lecture 19 [PDF]

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