Principals and agents : the structure of business

579 Pages·1991·7.73 MB·English

by  John W. Pratt

GAMES AND INFORMATION, FOURTH EDITION
An Introduction to Game Theory
Eric Rasmusen
Basil Blackwell
v

Contents1
(starred sections are less important)
List of Figures
List of Tables
Preface
Contents and Purpose
Changes in the Second Edition
Changes in the Third Edition
Using the Book
The Level of Mathematics
Other Books
Contact Information
Acknowledgements
Introduction
History
Game Theory’s Method
Exemplifying Theory
This Book’s Style
Notes
PART 1: GAME THEORY
1 The Rules of the Game
1.1 Definitions
1.2 Dominant Strategies: The Prisoner’s Dilemma
1.3 Iterated Dominance: The Battle of the Bismarck Sea
1.4 Nash Equilibrium: Boxed Pigs, The Battle of the Sexes, and Ranked Coordina-
tion
1.5 Focal Points
Notes
Problems
1xxx February 2, 2000. December 12, 2003. 24 March 2005. Eric Rasmusen, [email protected].
http://www.rasmusen.org/GI Footnotes starting with xxx are the author’s notes to himself. Comments
are welcomed.
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2 Information
2.1 The Strategic and Extensive Forms of a Game
2.2 Information Sets
2.3 Perfect, Certain, Symmetric, and Complete Information
2.4 The Harsanyi Transformation and Bayesian Games
2.5 Example: The Png Settlement Game
Notes
Problems
3 Mixed and Continuous Strategies
3.1 Mixed Strategies: The Welfare Game
3.2 Chicken, The War of Attrition, and Correlated Strategies
3.3 MixedStrategieswithGeneralParametersandN Players: TheCivicDutyGame
3.4 Different Uses of Mixing and Randomizing: Minimax and the Auditing Game
3.5 Continuous Strategies: The Cournot Game
3.6 ContinuousStrategies: TheBertrandGame,StrategicComplements,andStrate-
gic Subsitutes
3.7 Existence of Equilibrium
Notes
Problems
4 Dynamic Games with Symmetric Information
4.1 Subgame Perfectness
4.2 An Example of Perfectness: Entry Deterrence I
4.3 Credible Threats, Sunk Costs, and the Open-Set Problem in the Game of Nui-
sance Suits
*4.4 Recoordination to Pareto-dominant Equilibria in Subgames: Pareto Perfection
Notes
Problems
5 Reputation and Repeated Games with Symmetric Information
5.1 Finitely Repeated Games and the Chainstore Paradox
5.2 Infinitely Repeated Games, Minimax Punishments, and the Folk Theorem
5.3 Reputation: the One-sided Prisoner’s Dilemma
5.4 Product Quality in an Infinitely Repeated Game
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*5.5 MarkovEquilibriaandOverlappingGenerationsintheGameofCustomerSwitch-
ing Costs
*5.6 Evolutionary Equilibrium: The Hawk-Dove Game
Notes
Problems
6 Dynamic Games with Incomplete Information
6.1 Perfect Bayesian Equilibrium: Entry Deterrence II and III
6.2 Refining Perfect Bayesian Equilibrium: the PhD Admissions Game
6.3 The Importance of Common Knowledge: Entry Deterrence IV and V
6.4 Incomplete Information in the Repeated Prisoner’s Dilemma: The Gang of Four
Model
6.5 The Axelrod Tournament
*6.6 Credit and the Age of the Firm: The Diamond Model
Notes
Problems
PART 2: ASYMMETRIC INFORMATION
7 Moral Hazard: Hidden Actions
7.1 Categories of Asymmetric Information Models
7.2 A Principal-Agent Model: The Production Game
7.3 The Incentive Compatibility, Participation, and Competition Constraints
7.4 Optimal Contracts: The Broadway Game
Notes
Problems
8 Further Topics in Moral Hazard
8.1 Efficiency Wages
8.2 Tournaments
8.3 Institutions and Agency Problems
*8.4 Renegotiation: the Repossession Game
*8.5 State-space Diagrams: Insurance Games I and II
*8.6 Joint Production by Many Agents: the Holmstrom Teams Model
Notes
Problems
9 Adverse Selection
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9.1 Introduction: Production Game VI
9.2 Adverse Selection under Certainty: Lemons I and II
9.3 Heterogeneous Tastes: Lemons III and IV
9.4 Adverse Selection under Uncertainty: Insurance Game III
*9.5 Market Microstructure
*9.6 A Variety of Applications
Notes
Problems
10 Mechanism Design in Adverse Selection and in Moral Hazard with Hidden Informa-
tion
10.1 The Revelation Principle and Moral Hazard with Hidden Knowledge
10.2 An Example of Moral Hazard with Hidden Knowledge: the Salesman Game
*10.3 Price Discrimination
*10.4 Rate-of-return Regulation and Government Procurement
*10.5 The Groves Mechanism
Notes
Problems
11 Signalling
11.1 The Informed Player Moves First: Signalling
11.2 Variants on the Signalling Model of Education
11.3 General Comments on Signalling in Education
11.4 The Informed Player Moves Second: Screening
*11.5 Two Signals: the Game of Underpricing New Stock Issues
*11.6 Signal Jamming and Limit Pricing
Notes
Problems
PART 3: APPLICATIONS
12 Bargaining
12.1 The Basic Bargaining Problem: Splitting a Pie
12.2 The Nash Bargaining Solution
12.3 Alternating Offers over Finite Time
12.4 Alternating Offers over Infinite Time
12.5 Incomplete Information
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*12.6 Setting up a Way to Bargain: the Myerson-Satterthwaite Mechanism
Notes
Problems
13 Auctions
13.1 Auction Classification and Private-Value Strategies
13.2 Comparing Auction Rules
13.3 Risk and Uncertainty over Values
13.4 Common-value Auctions and the Winner’s Curse
13.5 Information in Common-value Auctions
Notes
Problems
14 Pricing
14.1 Quantities as Strategies: Cournot Equilibrium Revisited
14.2 Prices as Strategies
14.3 Location Models
*14.4 Comparative Statics and Supermodular Games
*14.5 Durable Monopoly
Notes
Problems
*A Mathematical Appendix
*A.1 Notation
*A.2 The Greek Alphabet
*A.3 Glossary
*A.4 Formulas and Functions
*A.5 Probability Distributions
*A.6 Supermodularity
*A.7 Fixed Point Theorems
*A.8 Genericity
*A.9 Discounting
*A.10 Risk
References and Name Index
Subject Index
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xxxSeptember6, 1999; February2, 2000. February9, 2000. May24, 2002. ArielKem-
per August 6, 2003. 24 March 2005. Eric Rasmusen, [email protected]; Footnotes
starting with xxx are the author’s notes to himself. Comments are welcomed.
Preface
Contents and Purpose
This book is about noncooperative game theory and asymmetric information. In the In-
troduction, I will say why I think these subjects are important, but here in the Preface I
will try to help you decide whether this is the appropriate book to read if they do interest
you.
I write as an applied theoretical economist, not as a game theorist, and readers in
anthropology, law, physics, accounting, and management science have helped me to be
aware of the provincialisms of economics and game theory. My aim is to present the game
theory and information economics that currently exist in journal articles and oral tradition
in a way that shows how to build simple models using a standard format. Journal articles
are more complicated and less clear than seems necessary in retrospect; precisely because
it is original, even the discoverer rarely understands a truly novel idea. After a few dozen
successor articles have appeared, we all understand it and marvel at its simplicity. But
journal editors are unreceptive to new articles that admit to containing exactly the same
idea as old articles, just presented more clearly. At best, the clarification is hidden in
some new article’s introduction or condensed to a paragraph in a survey. Students, who
find every idea as complex as the originators of the ideas did when they were new, must
learn either from the confused original articles or the oral tradition of a top economics
department. This book tries to help.
Changes in the Second Edition, 1994
By now, just a few years later after the First Edition, those trying to learn game
theory have more to help them than just this book, and I will list a number of excellent
books below. I have also thoroughly revised Games and Information. George Stigler used
to say that it was a great pity Alfred Marshall spent so much time on the eight editions
of Principles of Economics that appeared between 1890 and 1920, given the opportunity
cost of the other books he might have written. I am no Marshall, so I have been willing to
sacrifice a Rasmusen article or two for this new edition, though I doubt I will keep it up
till 2019.
What I have done for the Second Edition is to add a number of new topics, increase
the number of exercises (and provide detailed answers), update the references, change
the terminology here and there, and rework the entire book for clarity. A book, like a
poem, is never finished, only abandoned (which is itself a good example of a fundamental
economic principle). The one section I have dropped is the somewhat obtrusive discussion
of existence theorems; I recommend Fudenberg & Tirole (1991a) on that subject. The new
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topics include auditing games, nuisance suits, recoordination in equilibria, renegotiation
in contracts, supermodularity, signal jamming, market microstructure, and government
procurement. The discussion of moral hazard has been reorganized. The total number of
chapters has increased by two, the topics of repeated games and entry having been given
their own chapters.
Changes in the Third Edition, 2001
Besides numerous minor changes in wording, I have added new material and reorga-
nized some sections of the book.
The new topics are 10.3 “Price Discrimination”; 12.6 “Setting up a Way to Bargain:
The Myerson-Satterthwaite Mechanism”; 13.3 “Risk and Uncertainty over Values” (for
private- value auctions) ; A.7 “Fixed-Point Theorems”; and A.8 “Genericity”.
To accommodate the additions, I have dropped 9.5 “Other Equilibrium Concepts:
Wilson Equilibrium and Reactive Equilibrium” (which is still available on the book’s web-
site), and Appendix A, “Answers to Odd-Numbered Problems”. These answers are very
important, but I have moved them to the website because most readers who care to look at
them will have web access and problem answers are peculiarly in need of updating. Ideally,
I would like to discuss all likely wrong answers as well as the right answers, but I learn the
wrong answers only slowly, with the help of new generations of students.
Chapter 10, “Mechanism Design in Adverse Selection and in Moral Hazard with Hid-
den Information”, is new. It includes two sections from chapter 8 (8.1 “Pooling versus
Separating Equilibrium and the Revelation Principle” is now section 10.1; 8.2 “An Exam-
ple of Moral Hazard with Hidden Knowledge: the Salesman Game” is now section 10.2)
and one from chapter 9 (9.6 “The Groves Mechanism” is now section 10.5).
Chapter 15 “The New Industrial Organization”, has been eliminated and its sections
reallocated. Section 15.1 “Why Established Firms Pay Less for Capital: The Diamond
Model” is now section 6.6; Section 15.2 “Takeovers and Greenmail” remains section 15.2;
section 15.3 “Market Microstructure and the Kyle Model” is now section 9.5; and section
15.4 “Rate-of-return Regulation and Government Procurement” is now section 10.4.
Topics that have been extensively reorganized or rewritten include 14.2 “Prices as
Strategies”; 14.3 “Location Models”; the Mathematical Appendix, and the Bibliography.
Section 4.5 “Discounting” is now in the Mathematical Appendix; 4.6 “Evolutionary Equi-
librium: The Hawk-Dove Game” is now section 5.6; 7.5 “State-space Diagrams: Insurance
Games I and II” is now section 8.5 and the sections in Chapter 8 are reordered; 14.2 “Signal
Jamming: Limit Pricing” is now section 11.6. I have recast 1.1 “Definitions”, taking out
the OPEC Game and using an entry deterrence game instead, to illustrate the difference
between game theory and decision theory. Every other chapter has also been revised in
minor ways.
Some readers preferred the First Edition to the Second because they thought the extra
topics in the Second Edition made it more difficult to cover. To help with this problem, I
have now starred the sections that I think are skippable. For reference, I continue to have
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