Year 2023-2024

Game Theory and Strategic Behaviour

Topic 5. SEQUENTIAL GAMES

KEY CONCEPTS
• Sequential game with perfect information.
• Strategy of a player in a sequential game.
• Perfect Nash Equilibrium.
• Backward induction in finite sequential games.
• Strategic moves: threats, promises and commitments.
• Credibility of a strategic move.
 Year 2023-2024

MULTIPLE CHOICE QUESTIONS

1*. Consider the following game in extensive form:

1
A B

4
2 6

C D

1 3
5
E F

5 4
2 4

The Perfect Nash equilibrium is:

a) ((B,E),D) → (4,6).
b) ((A,F),D) → (3,5).
c) ((A,E),C) → (5,2).
d) ((B,F),D) → (4,6)

2*. Consider the following stage game repeated over a total of 10 periods.

C CD
C 3,3 0,4

CD 4,0 1,1

If both players discount future payoffs using a discount factor of 0 < 𝛿 < 1, under which conditions
can (𝐶, 𝐶) → (3,3) be sustained as an equilibrium of the repeated game?
a) With a grim trigger strategy and 𝛿 > 1/4.
b) With a grim trigger strategy and 𝛿 > 1/2.
c) With a grim trigger strategy and 𝛿 > 3/4.
d) In this context, using a grim trigger strategy is not going to work to sustain (𝐶, 𝐶) → (3,3) as an
equilibrium of the repeated game.
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SHORT QUESTIONS

3*. Two brothers are arguing over the distribution of a cake. The mother decides that the older
brother will cut the cake and the younger brother will choose the slice. How would you cut the cake
if you were the older brother?

4. “In a simultaneous game a dominated action cannot be part of a Nash equilibrium, but it can be
part of a Nash equilibrium strategy in a sequential game.” True or false.

5. Comment on the following statement by the 2005 Nobel Prize winner in economics, Thomas
Schelling: “The power to constraint an adversary depends upon the power to bind oneself.”

6*. Comment on the following statement by Maquiavelo: “You should never threaten what you don't
intend to do."
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PRACTISING THE BASIC CONCEPTS

7*. (PNE). Consider the share of four indivisible objects between two players where each player
must receive, at least, one object. Player 1 proposes the share and player 2 can accept or reject the
share. If he accepts the proposal, the share is implemented. If he rejects the proposal, both end up
with a payoff of 0. Obtain the strategies and Perfect Nash equilibrium of the game.

8. (PNE and credibility). Consider the following dynamic game with perfect information.

L R
2 2
r
l l r
m

2 0 1 2 4
2 1 5 0 1

a) Describe the players’ strategy sets.

b) Find the perfect Nash equilibrium of the game, explaining your answer.
c) Show a non-perfect Nash equilibrium of the game representing a threat and discuss its
credibility.

9. (Find the values for PNE). Consider the following extensive form game:

1
L R

𝑥 2
4
u d

2 1
1
l r

0 1
0 0
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a) Assume that 𝑥 = 1.5 and find the set of Nash equilibria and the Perfect Nash equilibrium.
b) Find the range of 𝑥 for which (R, u) is the unique Perfect Nash equilibrium path.
c) Find the range of 𝑥 for which L is a Nash equilibrium path.
 Year 2023-2024

STANDARD EXERCISES

10. (The value of a public contract to gain credibility). Consider the following dynamic game
between two neighbours who are deciding whether to build a swimming pool (a pure public good for
them). The cost is of 50 units (thousands of euros). It is known that neighbour A values the pool at
100 units and neighbour B at 90 units. Both players decide whether to contribute or not. If both
players decide to contribute, then they share the cost equally. If only one player decides to
contribute, he pays the entire cost. Finally, only if both players decide not to contribute, the
swimming pool is not built. The game is played sequentially under perfect information with
neighbour A moving first.

a) Find the Perfect Nash equilibrium of this game.

b) Suppose that neighbour B does not like the Perfect Nash equilibrium outcome of this game
and that before it is played, neighbour B can write a public contract with a third party,
agreeing to pay an amount 𝑥 to the third party in case the pool is built. Find what would be
the minimum and maximum value of 𝑥 that neighbour B would be willing to pay. Find the
Perfect Nash equilibrium for this situation, carefully explaining your answer.

11*. (Exam exercise). Consider two countries, R and U, which are in conflict. Country R moves first
and decides whether to initiate an attack or not. If country R does not initiate the attack, the game
ends peacefully (with payoffs of 1 for each country). If country R initiates the attack, country U
moves second and decides whether to give in or to fight. If country R attacks and country U gives in,
the payoffs are 3 for country R and -2 for country U. If country U decides to fight, the payoffs are −𝑐
for each country.
a) Define perfect Nash equilibrium.
b) Assume that 𝑐 = 3. Represent this game in extensive form. Obtain the perfect Nash
equilibrium. Identify a Nash equilibrium based on a non-credible threat. Discuss the
efficiency of the results.
c) Assume that 𝑐 = 3 and an international body imposes a sanction of 𝑥 on country R in case of
attack. What would the minimum sanction 𝑥 have to be to deter the attack? Obtain the
perfect Nash equilibrium/a as a function of 𝑥.

(Final Exam GECO, June 2023)

12. (Altruist mother and selfish son. Social preferences do not always make a threat credible).
Consider the following game, where C denotes cooperation and NC non-cooperation:

C NC
C 2,2 0,3
NC 3,0 1,1
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Suppose that this game is played sequentially and with perfect information between a son (Player 1)
and his mother (Player 2). The son is selfish; his utility coincides with his material payoffs (𝑥! ),
shown in the matrix. But the mother is altruist; her utility is given by the sum of both material payoffs,
that is, 𝑢" = 𝑥" + 𝑥! . Assume that the son (Player 1) moves first.

a) Draw the tree for this game and describe the players’ strategy sets. Find the Perfect Nash
equilibrium of the game, explaining your answer. Show a non-perfect Nash equilibrium of the
game representing a threat and discuss its credibility.
b) Suppose now that there is a change in the order of moves and the mother moves first. Does
the outcome of the game change?
c) Describe and explain, with the same order of moves of the previous section (a), any credible
strategic move of the mother that might induce the son’s cooperation.

13*. (Dividing the prize. Changing the order of the game or public contract). Two people play a
game in which they choose and divide a prize. Player 1 chooses how to divide the prize: he can
choose either an equal division or a split, where he gets 90% and his opponent gets 10%. Player 2
decides how large the total prize should be: she can choose either 100 or 10. Assume that this
game is played sequentially under perfect information. In particular, Player 1 moves first choosing
one of his two actions and, after observing this choice, player 2 makes her decision.

a) Draw the tree for this game and describe the players’ strategy sets. Find the Perfect Nash
equilibrium of the game, explaining your answer. Show a non-perfect Nash equilibrium of the
game representing a threat and discuss its credibility.
b) Player 2 can now choose between these alternatives: to change the order of moves in the
game, moving herself first or, alternatively, with the same order of moves of the previous
section, to write down a public contract with a third party (let’s say a N.G.O. for example)
committing to pay 10 to the third party in case Player 2 chooses a prize 100 in the game with
Player 1. Draw the tree and find the Perfect Nash equilibrium for both alternatives and
explain if Player 2 should choose any of them.

14. (How to achieve cooperative results by repeating a sequential game. Efficiency wages). A
company offers a wage 𝑤 to a worker. He accepts or rejects the offer, in which case he gets a
reservation wage 𝑤# = 4, in another occupation. If he accepts, he chooses to exert a high effort
with cost 𝑐 = 2 or a low effory with cost zero. In the first case, a gross revenue of 10 is obtained for
the company. In the second case, the revenue obtained is zero.
a) Suppose that this relationship occurs over a single period and the effort and level of revenue
were not verifiable (contractable). What would the result in this situation be?
b) What would happen if the relationship were prolonged for 4 periods?
c) Now the relationship can be prolonged indefinitely (with an infinite horizon) and revenue,
although not verifiable, is observable after each period. Describe a pair of strategies for the
company and the worker, in which they condition their action in each period to past history,
with which it is possible to implement all the periods high effort and income. Calculate the
minimal wage 𝑤 that the company will have to pay, so that this pair of strategies constitutes
an equilibrium of the repeated game. Suppose the employee’s discount factor is 𝛿 = 0.8.
 Year 2023-2024

15. (Repeated trust game with social preferences). An investor (Player 1) has funds worth 10.
Player 1 may or may not trust a manager (Player 2) who would triple the value of the investment. If
he does not trust, he continues to hold these funds. If you trust, the problem is that the manager can
behave honestly by returning half of these returns or be dishonest and return only worth 9 (arguing
management costs are worth 1) and keeping the rest for himself.
a) Draw the tree for this game and find the Perfect Nash equilibrium of the game. Discuss its
efficiency.
b) What would happen if the situation were repeated for 24 periods?
c) What would happen if this situation were repeated indefinitely period after period (i.e. with an
infinite horizon)? Calculate under which conditions the investor would trust all periods.

Let's return to the situation in section (a), i.e. the game is played only once.

d) Suppose now that the manager displays advantageous inequality aversion, with a utility
function 𝑈" (𝑥! , 𝑥" ) = 𝑥" − 0.8 𝑚𝑎𝑥{𝑥" – 𝑥! , 0}, where 𝑥! and 𝑥" are both players material
payoffs. Draw the tree for this game and find the Perfect Nash equilibrium.
e) Suppose that the manager is selfish but the investor has a utility function 𝑈! (𝑥! , 𝑥" ) = 𝑥! −
2𝑚𝑎𝑥{𝑥" – 𝑥! , 0}. In addition, the investor can now impose a penalty on the manager of 15
but with a cost of 8 to himself. Represent the tree of this game and obtain the Perfect Nash
equilibrium, what would happen in this case if the investor were selfish?
 Year 2023-2024

ADVANCED EXERCISES

16*. (Teamwork in 3 overlapping generations: Infinitely and finitely repeated games). A team of
three workers jointly produce a good every period in a repeated situation with infinite horizon. The
level of output depends on the non-verifiable work effort made by each of the individuals. Effort can
take two values, 𝑒$ Î {1, 2}. The total revenue is 𝑅 = 9(𝑒! + 𝑒" + 𝑒% ). The individual cost of effort
is given by the functions 𝑐(𝑒$ ) = 4𝑒$ . Total revenue is equally shared. Each worker works only three
periods. In each period, the team is composed by workers of all generations, that is, there is a
player in his first period (effort 𝑒! ), another player in her second period (effort 𝑒" ) and a third player
in his third and last period (effort 𝑒% ). Assume for simplicity that all players have the same discount
factor d = 0.9. Find a Perfect Nash equilibrium of the repeated game in which everybody, except
the player in his last working period, chooses the high level of effort. What would happen if there
were a player with d = 0.4? Explain your answer.

17*. (Ultimatum game with selfish players and social preferences). Consider an ultimatum game
where Player 1 (proposer) offers Player 2 (responder) a share of 100€, in 1€ coins. If the responder
accepts, the proposed share is implemented. If he rejects, both obtain a payoff of zero.
a) Obtain the Perfect Nash equilibrium of this game.
b) If the responder had a utility function such that 𝑈" (𝑥! , 𝑥" ) = 𝑥" − 2 max{𝑥! − 𝑥" , 0}, where 𝑥!
and 𝑥" are players’ material payoffs. What would the Perfect Nash equilibrium be?

18. (Stackelberg duopoly). In a market with a homogeneous product, Firm 1 (leader) chooses a
production level 𝑥! . After observing it, Firm 2 (the follower), chooses its production level 𝑥" .
Consumers buy following the inverse demand function 𝑃(𝑋) = 9 − 𝑋, where 𝑋 = 𝑥! + 𝑥" . Costs for
both firms are zero, 𝑐! = 𝑐" = 0. Analyse this sequential game with perfect information.
 Year 2023-2024

STRATEGIC SITUATION – GAME IN THE NEWS

Read the following news article (El Heraldo de Aragón, 2023) and answer the following questions:

Europe declares war on Chinese electric cars

When China began to open up to the world in the 1980s, it knew that it could not compete with the West in
technologies that were already mature. Therefore, it decided to gain market share on price. Now that China is
the only superpower capable of ending the hegemony of the United States, its multinationals are committed to
lead the development of technologies that will mark the future, and in which they can compete: from artificial
intelligence and robotics to genetic engineering and space exploration.

Electric mobility is one of the ten pillars of the government's 'Made in China 2025' strategy, and one of the few
that is already launching products to the market. Chinese electric and plug-in hybrid cars have become one of
China's fastest growing exports thanks to their unbeatable value for money. Overseas sales have increased in
160% in the first half of the year, up to 554 000 units.

This is data that has begun to worry the EU authorities. They suspect that Chinese brands, including state-
owned companies, are benefiting from subsidies that violate free market rules and harm their competitors,
which is why they have opened an investigation that threatens to trigger a new trade war whose
consequences may affect many other sectors.

"The electric vehicle sector offers enormous potential for the future competitiveness and leadership of
Europe's green industry. European car brands are already investing in developing this potential. We will act
decisively where we find evidence that their efforts are being affected by market distortions and unfair
competition," justified the European Commission President Ursula von der Leyen. "This anti-subsidy
investigation will be thorough, fair and fact-based," she promised.

In China, however, her words have sounded like war drums. Beijing has branded the measure as
"protectionist" and has already warned that the world's second-largest automaker may also respond with
harmful restrictions on the European automotive sector.

Threat of retaliation
This is confirmed by Fernando Miguélez, head of the National Association of Motor Vehicle Dealers, Repairs
and Spare Parts (Ganvam), with a hard fact: "The European automotive industry exports vehicles and
components worth 24,000 million euros to China, but only imports 9,000 million".

Águeda Parra, geopolitical environmental analyst at China Geotech, agrees: "Countries where the automobile
is key to their economy, such as Germany - which China overtook as the second largest exporter of vehicles
last year - are highly dependent on the Asian giant’s sales". In other words, if the European Commission
decides to impose barriers on Chinese vehicles, which still accounts for less than 4% of all vehicles sold in the
Old Continent, the Communist Party could respond with measures that would have a much greater impact,
given that brands such as Volkswagen place more than a third of their global production in the Asian giant.

But does China subsidise local brands? A Spanish employee of a major German brand based in Shanghai is
clear: "Many purchase subsidies have been approved, although these do not differ much from the Spanish
Moves Plans, and it is not known to what extent the government has financed the development of electric
vehicle technologies because everything is very opaque, and many brands are state-owned. Camouflaging
subsidies is very easy. The fact is that the sector is a priority for China and a lot of resources have been
channelled into it. However, he also stresses that Chinese cars are ahead of European cars in terms of
performance. "We have been overconfident and we haveunderestimated the Chinese," he says.
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Miguélez believes it is possible that Western brands "have rested on their laurels" and stresses that Chinese
cars are of good quality. "They cover a part of the demand for which there was no supply, especially for small
and medium-sized cars. If we export high-end cars to China, they come with good value for money.

But Parra does not believe that this advantage is the result of a 'dumping' strategy, i.e. selling below cost price
to gain market share: "The costs associated with the manufacture of electric cars in China are lower because
there is vertical integration in the companies. Brands like BYD are miners, they refine the raw materials and
manufacture the batteries, the most important element of the car. Then all that's left is to put it on a chassis.

The analyst points out that China also controls key elements such as rare earths and lithium, as well as the
production of automotive chips, and is several years ahead in the field of batteries, where Europe is only now
trying to catch up. It is not surprising that more than a decade ago the streets of the Grand Dragon were
already filled with electric motorbikes, the first step towards plug-in mobility that now extends to all vehicles.

In Europe, however, Chinese cars still account for only 8% of pure electric sales. "However, in 2019 they were
1% and by 2030 they are expected to reach 30%," Parra stresses. "China has seen an opportunity in the
electric car and is taking advantage of it," says Miguélez. "The automotive sector is at a turning point where all
the links in the chain are undergoing profound changes. There is a lot of uncertainty about the technology that
will drive the car of the future because there are also green fuels and hydrogen. The Chinese government,
however, has made an unwavering commitment to electric, and we may soon start to see solid batteries that
will bring new benefits," he explains.

In the new vehicles, one of the most important elements is what they call 'infotainment', a term that
encompasses the various software systems that provide information and entertainment. A good example of
this is the huge screen in Tesla cars. And, in China, on-board karaoke equipment is a big hit. "When it comes
to software, the Chinese are way ahead of us. Our systems are slower and duller," admits the German
brand's employee, who sees a 'tiktokisation' of the automotive industry. This is not a gratuitous comparison:
the Chinese social network has demonstrated China's disruptive capacity. "They are innovating a lot in the car
experience," he adds. It is something that can be seen in sales in the world's second-largest country, where
BYD has overtaken Volkswagen to take the throne.

Chinese brands in Europe

At this situation, Europe is beginning to take measures that Miguélez describes as double standards. "It is
good that they are investigating to see what is behind Chinese production. But what happens with car brands
is identical to what happens with mobile phone brands. And in that case, there was no problem. The
difference is that now it is not convenient because Europe does have a car industry," he says.

The big question is whether the European brands will be able to close the gap with the Chinese. In this
respect, Parra believes that the Next Generation funds could be key. "What will happen is that the Chinese
brands will come to Europe to produce," he says, pointing out that there are already several companies
looking for the ideal location for this manufacturing, and that Spain is in the running. These investments are an
incentive for the European Commission not to draw its sabres. "Europe is more pragmatic than the United
States and China is not interested in another conflict like the one opened by Donald Trump," the analyst adds,
confident that it will not come to much and that the rules of the market will dictate the verdict.

Reference: El Heraldo de Aragón (2023, 22nd April). Europe declares war on Chinese electric cars.
El Heraldo de Aragón [online].
https://www.heraldo.es/noticias/economia/2023/10/22/automovil-europa-le-declara-la-guerra-al-
coche-electrico-chino-1685834.html [2023, 22nd October]
 Year 2023-2024

Questions

Consider that this game is played simultaneously between the European Commission and China.
a) Present this game in strategic form proposing payoffs such that it has the structure of a
chicken game.
b) Obtain the players’ best response functions and the Nash equilibria. Which Nash equilibria
would each player prefer?

Consider now that this game is played sequentially and that the European Commission moves first.
c) Represent this game in extensive form using the payoffs from section (a).
d) Find the Perfect Nash equilibrium and a non-perfect Nash equilibrium that represents
China’s threat to the European Commission. Explain your answer.

Read the following link to see more: https://cincodias.elpais.com/opinion/2023-10-21/las-

restricciones-de-pekin-al-grafito-lanzan-un-disparo-de-aviso-verde.html