Unit 4

Social Interactions:
An introduction to Game Theory
Objectives
• Social Dilemmas
• Game theory concepts
• Introduction of games
o Invisible hand game
o Prisoner’s Dilemma: Two players
o Ultimatum game
o Repeated games and the Tit-for-tat strategy
o Chicken game
o Hawk Dove game (variant of chicken game)
Important Concepts:
• Games & Strategic Interactions
• Strategies, Outcomes & Payoffs
• Best Response
• Dominant Strategy
• Social Dilemma
• Nash Equilibrium*
Important Concepts:
Games & Strategic Interactions
• A strategic interaction be anything where two or more agents/people make choices that
effects the other(s)
• E.g. playing chess: your choice of a move will influence the choices of your opponent = Game
• E.g. you own a store and decide to decrease the price of a product that your competitor also
sells. You might steal some market share from them and so your decision has influenced their
payoff (profit)
• E.g. you organized to meet a friend at either Mugg & Bean or Col’Cacchio, but your phone has
died and now you cannot confirm where to meet them. You have to choose which one of the
restaurants you go to, hoping that you will meet your friend there. Your choice of restaurant
effects your (as well as your friend’s) utility.

• Games are a model of strategic interactions between two or more agents.

Important Concepts:
Strategies, Outcomes & Payoffs
• A strategy is choice that a player may take in a social interaction (the player is aware of the
mutual dependence of that action’s outcome on themselves and others).
• The outcome of a strategic interaction is determined by the players’ choice of strategy; the
situation that results from the combination of strategies by players.
• We usually state the result of the outcome of a game in terms of payoffs: what players can
earn given the different outcomes/combinations of strategies.
• When you play rock, paper, scissors against a friend and the winner gets 50 bucks:
• Your strategy is the hand sign you play
• The outcome is determined by the combination of hand signs that you and your
opponent play (e.g., if you play rock and your opponent plays scissors, you win)
• The payoff is 50 bucks for the winner and nothing for the loser
Important Concepts:
Payoffs
• We often represent a payoff in terms of the utility a player receives given a certain outcome.
• But we can also represent it in terms of how much money a person can receive given an
outcome
• Or we can even represent a payoff in terms of punishment (e.g. how many years in prison
someone gets for committing a crime, in which case the goal is to have an outcome that gives
the players the lowest payoff)
Important Concepts:
Best Response
• Imagine you are a goalkeeper in a football match. There is a penalty shootout. You need
to decide in which direction you dive to save the ball from going into the goal…
• Which direction do you dive if the player kicks the ball to your right?
• Which direction do you dive if the player kicks the ball to your left?
• You choose to dive in the direction they kick it! Because it is your best response to
the choice your opponent has made in terms of where they kick the ball.
Important Concepts:
Dominant Strategy
• Imagine you and your arch-nemesis are competing in a high-stakes staring contest.
You both have a simple decision:
1. Blink normally
2. Force yourself not to blink

• No matter what your opponent does, not blinking is always your best option:
• If they blink, you win.
• If they also don’t blink, at least you don’t automatically lose.
• Since keeping your eyes open is always the best strategy, no matter what the
other player does, it’s your dominant strategy.
Important Concepts:
What is not Dominant Strategy?
• Remember the goalkeeper example from a few slides back? That is an example of a
game that does not have a dominant strategy.
• Why?
• As a goalkeeper, you have two strategies: dive left or dive right.
• Your choice of diving direction (strategy) depends on the direction your opponent
kicks the ball (opponent’s strategy)
• I.e. if your strategy changes given that your opponent’s strategy changes, the solution
cannot be a dominant strategy.
Important Concepts:
Social Dilemma
• In the context of a game, a social dilemma occurs when the choices of the players lead to
suboptimal outcomes.
• If the players worked together, both will be better off.
• In other words, the solution of the game is an outcome that gives both players lower
payoffs than they could have received if they made different choices.
• Examples: tragedy of the commons, free riding, pollution

Formal definition: A situation in which actions taken independently by self-interested

individuals result in a socially suboptimal outcome
Let’s model strategic interactions with
Game Theory
What games are we going to study?
• Game Theory is a fascinating, but incredibly complex field.
• There are many different types of games: incomplete
information, sequential games, cooperative games, etc.
• This is unit is a very gentle introduction to Game Theory
• We will only study one type of game model: non-cooperative
simultaneous games with full information
• We only look at games between two players and at most two
actions that any one player can take at a time.
Typical Model Assumptions
• There are no other people involved in the social interaction
• Players will interact just once (‘one-shot’ game)
• Players know what the payoffs are given different outcomes
• Player decisions are made simultaneously; they are both
unaware of the decision that the other player made
• Players will always act in their own self-interest and will try to
maximise their own payoff (they don’t care about the other
player’s payoff, only their own)
Typical Model Setup
• We normally model games as matrices/tables like the one below.
• We show the different actions/strategies players can take.
• We state the payoffs of the different players.
• By convention, the row player’s payoffs are listed first, followed by the column player

Column Player
Action 1 Action 2
Action 1

payoff_row , payoff_row ,
payoff_column payoff_column
Row Player
Action 2

payoff_row , payoff_row ,
payoff_column payoff_column
Let’s model a game
• Two farmers, Bean and Bunce, need to decide which crops to
plant.
• They can plant wheat or corn.
• If both plant wheat, there will be too much wheat on the market
and a shortage of corn; and vice versa.
• Bean is better at producing wheat and Bunce is better at
producing corn.
Let’s model a game
• We know there are four possible outcomes:
1. Both farmers plant wheat
2. Both farmers plant corn
3. Bean plants wheat and Bunce plants corn
4. Bean plants corn and Bunce plants wheat
• We know that the farmers will get higher payoffs for planting the crop they
specialise in.
• We know that the farmers will get higher payoffs if they do not plant the
same crop
Let’s model a game
• So, let’s give hypothetical payoffs (in terms of utility) for what
each outcome can yield for each farmer/player:

1. Both farmers plant wheat: Bunce gets 1, Bean gets 3

2. Both farmers plant corn: Bunce gets 3, Bean gets 1
3. Bean plants wheat and Bunce plants corn: Bean gets 4,
Bunce gets 4
4. Bean plants corn and Bunce plants wheat: Bean gets 2,
Bunce gets 2
Let’s model a game
• So, let’s give hypothetical payoffs (in terms of utility) for what
each outcome can yield for each farmer/player:

Bean
Wheat Wheat Corn

1,3 2,2
Bunce
Corn

4,4 3,1
Let’s model a game: Solution?
• We want to know what Bean
actions the players will Wheat Corn
take.

Wheat
• Suppose Bean chooses 1,3 2,2
Wheat. What should

Bunce
Bunce choose?

Corn
4,4 3,1
Let’s model a game: Solution?
• If Bunce chooses Wheat, Bean
his payoff is 1 Wheat Corn
• If Bunce chooses Corn,

Wheat
his payoff is 4 1,3 2,2

Bunce
• If Bunce is rational, he will
choose Corn, because it

Corn
gives him the highest 4,4 3,1
payoff
• This is Bunce’s best
response to Bean’s
action
Let’s model a game: Solution?
• If you highlight the best Bean
response to a given action for Wheat Corn
each player, you arrive at the
solution of the game

Wheat
• Here I highlighted Bean’s best 1,3 2,2

Bunce
responses to each of Bunce’s
actions in yellow

Corn
• Here I highlighted Bunce’s 4,4 3,1
best responses to each of
Bean’s actions in pink
Let’s model a game: Solution?
• The solution of this game is Bean
when Bunce chooses Corn Wheat Corn
and Bean chooses Wheat

Wheat
• We state the solution as a
strategy combination: (Corn, 1,3 2,2

Bunce
Wheat)
• This solution is called the

Corn
Nash Equilibrium 4,4 3,1
Important Concept:
Nash Equilibrium (NB!)
• Formally defined as: A Nash equilibrium is an equilibrium where no player has an
incentive to unilaterally change their strategy.
• What does this mean?
• Quite simply, if a player has chosen their strategy, they cannot get a better payoff by
switching to a different strategy (while holding the other player’s strategy constant.
• A Nash equilibrium is like choosing a side in a water balloon fight.
• If you and your rival both take cover behind different walls, neither of you wants to
move—because stepping out would get you soaked.
• If you both stay put, neither of you gains anything by switching.
• Once you've both made your choice, changing your position doesn’t help unless
the other person also changes. That’s a Nash equilibrium.
John Nash (1928-2015)
Nash’s doctoral dissertation applied
game theory to economics and
introduced the idea of a Nash
equilibrium:
• Nash and two colleagues won the
Nobel prize in economics in 1994
“for their pioneering analysis of
equilibria in the theory of non-
cooperative games.”
The Solution to a Game
• In our model of the interaction Bean
between Bunce and Bean, we
determined the Nash Equilibrium Wheat Corn
which is also the solution of the

Wheat
game.
• What does it mean that this is the
1,3 2,2

Bunce
solution?
• The solution of this strategic
interaction tells us what rational

Corn
players will do when faced with 4,4 3,1
this situation. Can you see how
this is important for us to know?
Dominant Strategy and Nash
Equilibria
• In our game between Bunce and Bean, the solution is called the Nash
Equilibrium.
• But in this particular game, the Nash equilibrium is also a dominant
strategy equilibrium.
• A dominant strategy equilibrium is a characteristic of the solution.
• Why is this a dominant strategy?
• What was Bean’s best response to Bunce playing Wheat? Wheat!
• What was Bean’s best response to Bunce playing Corn? Still Wheat!
• So, Bean’s strategy does not change, regardless of what Bunce’s
strategy is.
• Therefore, it is a dominant strategy.
A few notes regarding the solution
• Every game has at least one Nash equilibrium (proven by John Nash).
• There can be more than one Nash Equilibrium.
• Not every game has a dominant strategy equilibrium.
• Therefore, a dominant strategy equilibrium is always also a Nash
equilibrium, but a Nash equilibrium is not necessarily a dominant
strategy equilibrium
What other characteristic does this
game have?
• Look at the payoffs that each Bean
player gets at the Nash Wheat Corn
equilibrium.

Wheat
• Is there a better outcome? In
other words, is there a 1,3 2,2

Bunce
combination where both
players are better off?

Corn
• No! 4,4 3,1
• This game is known as the
Invisible Hand game
Invisible Hand Game
• The Invisible Hand game is a game in which the equilibrium is also the
best outcome socially
• It refers to a scenario where individuals acting in their own self-interest,
without any central coordination, unintentionally create a beneficial
outcome overall.
• The "invisible hand" guides individuals to make decisions that ultimately
benefit society as a whole, even if their primary motivation is personal gain
Let’s look at other games: Prisoner’s
Dilemma
• Technically, there are 144 distinct 2×2 (ordinal) games (the
Invisible Hand is just one of them)
• One of the most famous games is the Prisoner’s Dilemma.
• It is an example of a game that leads to a social dilemma.
• Unlike the Invisible Hand, the solution to the Prisoner’s
Dilemma is a Nash Equilibrium that delivers socially
suboptimal outcomes.
The Prisoners’ Dilemma
Accuse vs Deny
• Two prisoner’s (Red & Blue)
• Two strategies:
• Implicate the other prisoner in a crime (accuse)
• Deny that the other prisoner was involved
(deny)
• Four hypothetical outcomes
• Both accuse, and are sentenced to 5 years
prison each
• Both deny, and receive 4 years prison each
• Accuse whilst the other denies, with the
accuser being freed for cooperation and the
denier receiving 10 years
 The Prisoners’ Dilemma
Note: Payoffs are in years of
imprisonment, so players
Blue prefer lower numbers
(disutility)
Accuse Deny
Accuse

5,5 0 , 10 What is the equilibrium

outcome of this game?
Red
Deny

10 , 0 1,1
 The Prisoners’ Dilemma

Blue • The equilibrium is

(Accuse, Accuse)
Accuse Deny
•
Accuse

Can you see how this

5,5 0 , 10 is a social dilemma?
• There is an outcome
Red

that gives both players

a better payoff: (Deny,
Deny

10 , 0 1,1 Deny)
The Prisoners’ dilemma: Another Example
• Bala and Anil face a different problem:
• → How to deal with pests?

• Feasible strategies:
• Use an inexpensive chemical
(Terminator) that kills all insects, but
contaminates the water that they both
drink
• Use an integrated pest control (IPC)
that introduces beneficial insects as a
natural predator

• Information:
• Their fields are adjacent
• If one player chooses Terminator the
damage is limited, but if both choose
Terminator the damage is severe
The Prisoners’ dilemma: Another Example
Bala
IPC Terminator

Beneficial insects Bala’s chemicals spread to

eliminate all pests Anil’s fields, and all insects
IPC

(beneficial & pest)

No water eliminated
contamination Limited water
Anil

contamination
Termimator

Anils’ chemicals spread to

Eliminates all pests
Bala’s fields, and all insects
Heavy water
(beneficial & pest) eliminated
contamination
Limited water contamination
Costly filtration
The Prisoners’ dilemma: Another Example
Bala
IPC Terminator
IPC

3, 3 1, 4
Anil
Termimator

4, 1 2, 2
The Prisoners’ dilemma: Another Example
Bala
IPC Terminator
IPC

3, 3 1, 4
Anil
Termimator

4, 1 2, 2
The prisoners’ dilemma
Bala
IPC Terminator
Anil’s best response is?
Anil’s dominant strategy is?

IPC
3, 3 1, 4
Bala’s best response is?

Anil
Bala’s dominant strategy is?

Termimator
4, 1 2, 2
The prisoners’ dilemma
Bala
IPC Terminator
The outcome (Terminator,
Terminator) is a Nash equilibrium
AND a dominant strategy

IPC
3, 3 1, 4
equilibrium.

Anil
Both players would be better off with

Termimator
the outcome (IPC, IPC).
4, 1 2, 2
 Where do
we see
prisoners’
dilemmas?

Traffic jams Climate change

Social preferences
• Individual self-interest generates an
efficient solution in the invisible hand
game.
• Individual self-interest generates a social
dilemma in the prisoners’ dilemma game.
• Social preferences can help people solve
social dilemmas.

Why don’t you pick other people’s

pockets? (Credit: Kaushik Basu’s Beyond
the Invisible Hand) Beyond the Invisible
Hand | Princeton University Press
Examples of social preferences
Altruism - selfless concern for the well-being of others.

Reciprocity – a situation in which two people or groups

perform mutual or corresponding actions based on the
actions of the other.

Inequality aversion - the tendency of individuals to avoid

situations where they perceive that there is an unfair
distribution of resources or benefits
Why don’t you pick other people’s
pockets? (Credit: Kaushik Basu’s Beyond
Spite - to intentionally annoy, upset, or hurt someone the Invisible Hand) Beyond the Invisible
Hand | Princeton University Press
 Learning about preferences
Economists sometimes use experiments to learn about preferences.
1. Lab experiments:
• Can control participants’ decisions and
their outcomes.
• Can create a control/treatment group for
comparison.
• Results can be replicated.
• Can control for other variables.
2. Field experiments:
• Lab experiments may not predict real-world
decision making.
• More realistic context in which people make
decisions.
Other games?
Ultimatum game – one shot game
• The ultimatum game is a common experimental economics game in which
two parties interact anonymously and only once
• The ultimatum game is used to study preferences
• It has been used around the world with experimental subjects including
students, farmers, warehouse workers, and hunter gatherers

• By observing their choices, we investigate the

subjects’ preferences and motives, such as pure
self-interest, altruism, inequality aversion, or
reciprocity
 Ultimatum game – one shot game
• Random pairs of players (identities held anonymous) are created, with one
randomly assigned in the role of “Proposer” and the other in the role of
“Responder”
• Proposer is given an amount of money, say R100, and instructed to offer the
Responder part of it
“𝑥 for me, 𝑦 for you”

• After observing the offer, the Responder can either

accept or reject it (take-it-or-leave-it offer)

• If rejected, both get nothing; if accepted, the Proposer

gets 𝑥 and the Respondent gets 𝑦
Ultimatum game –
one shot game
• Let’s say the Proposer offers R35 and the Responder accepts
→ the Proposer gets R65 and the Responder gets R35
• If the Responder rejects the offer
→they both get nothing.
• This is called a take-it-or-leave-it offer. It is the ultimatum in the
game’s name.
• The Responder is faced with a choice: accept R35 or reject
and get nothing.
→ Therefore, R35 is the opportunity cost of rejecting the offer
• The game is about sharing economic rents that arise in an
interaction
Ultimatum game –
one shot game
• We see that in the ultimatum game one player
(the Proposer) chooses her strategy first,
followed by the Responder.
o This is called a sequential game;
previously we looked at simultaneous
games, in which players chose strategies
simultaneously.
• What the Proposer will get depends on what the
Responder does, so the Proposer has to think
about the likely response of the other player.
• That is why this is called a strategic
interaction.

What should the Proposer do?

 Ultimatum game – one shot game

Outcome of the The Responder will The Proposer In real word → much
game: accept any offer as should anticipate higher splits,
it places them in a this and offer the usually around 50-
better position lowest possible 50. The actual split
(getting something offer to receive the differs from the
is better than highest possible predicted split due
getting nothing) payoff to social
The Proposer offers R1 preferences.
The Responder accepts
this R1 since they are
better off than they are
when rejecting the offer
(get R0)
Proposer thus gets R99
 Tit-for-tat strategy and repeated games
• In the prisoner’s dilemma game, there was no way for Anil or Bala to make
sure that whoever used the insecticide pay for the harm caused
• Interaction between Anil and Bala in our model was a one-shot game.
• But as owners of neighbouring fields, Anil and Bala are more realistically
portrayed as interacting repeatedly.

Suppose that Bala has adopted IPC. What is Anil’s best

response (given that they interact repeatedly, every
season)?

Anil’s response: If I play IPC, then maybe Bala will continue to do so, but if I use
Terminator—which would raise my profits this season—Bala would use Terminator next
year. So unless I am extremely impatient for income now, I’d better stick with IPC.
Tit-for-tat strategy
and repeated
games
• The tit-for-tat strategy involves the
threat of a punishment
o This strategy reciprocates against
defectors, so if a player defects,
this can be reciprocated by
punishment in the next round of
the game

• Players in a repeated game have a

higher incentive to cooperate
The Chicken
Game
The Chicken Game
Player 2
Swerve Straight
What is the equilibrium
outcome of this game?
Swerve

0, 0 -1, 1
Is it a Nash
Player 1

equilibrium?
Straight

1, -1 -1000, -1000
The Chicken Game
Player 2
Swerve Straight
What is the equilibrium
outcome of this game?
Swerve

0, 0 -1, 1
Is it a Nash
Player 1

equilibrium?
Straight

1, -1 -1000, -1000
Variant: Hawk-Dove Game
Player 2
Back down Enforce
worldview
Back down

0, 0 -1, 1
Player 1

worldview
Enforce

1, -1 -1000, -1000
Variant: Hawk-Dove Game
Player 2
Back down Enforce
worldview
Back down

1, 1 -1, 1
Player 1

worldview
Enforce

1, -1 -1000, -1000
 In the next
unit
• The role of institutions in social allocations

• How to evaluate social outcomes: efficiency and

fairness

• How bargaining power affects the distribution of

surplus