Game Theory
Chapter 14
Slides by Pamela L. Hall
Western Washington University
©2005, Southwestern
Introduction


Game theory considers situations where agents (households
or firms) make decisions as strategic reactions to other
agents’ actions (live variables)
 Instead of as reactions to exogenous prices (dead variables)
One of the most general problems in economies is
outguessing a rival
 For example, a firm seeks to determine its rival’s most profitable
counterstrategy to its own current policy
• Formulates an appropriate defensive measure


For example, in 1996 Pepsi supplied its cola aboard Russia’s space station Mir
 Coca-Cola countered by offering its cola aboard shuttle Endeavour
In this chapter, we see how theory of how agents interact
(called game theory) has extended classical approach
 By considering in greater detail interaction among firms in oligopoly
markets
2
Introduction

Game theory provides an avenue for economists to investigate and develop
descriptions of strategic interaction of agents
 Strategic interdependence
• Each agent’s welfare depends not only on her own actions but also on actions of other agents
(players)
• Best actions for her may depend on what she expects other agents to do

Theory emphasizes study of rational decision-making based on assumption that
agents attempt to maximize utility
 Alternatively, agents’ behavior could be expanded by considering a sociological,
psychological, or biological perspective

Recent progress in game theory has resulted in ability to view economic
behavior as a special case of game theory
 In economics, this strategic interdependence among agents is called noncooperative
game theory
• Binding agreements among agents are not assumed
• Cooperation may or may not occur among agents as a result of rational decisions
 In contrast to cooperative game theory, where binding agreements are assumed
• For example, interaction of two football teams playing a game is non-cooperative
• In contrast, two people forming a loving relationship to jointly increase their welfare is a
cooperative game
3
Introduction

Strategic interdependence of perfectly competitive firms or a monopoly firm is
either minor or nonexistent
 Models of perfect competition and monopoly do not require incorporating game theory
 In contrast, strategic interdependence is a major characteristic of imperfect
competition
• Game theory has become the foundation of models addressing imperfect-competition firm
behavior

Economic models based on game theory are abstractions from strategic
interaction of agents
 Allows tractable interactions, yielding implications and conclusions that can then be
used for understanding actual strategic interactions


In this chapter, we first develop both strategic and extensive forms of game
theory
In discussing Prisoners’ Dilemma we see difficulties of obtaining a cooperative
solution without some binding agreement
 However, we show a cooperative solution may result if game is played repeatedly
 Prisoners’ Dilemma games assume that all players move simultaneously
4
Introduction

An alternative set of games are sequential games
 One player may know other players’ choices prior to making a
decision
 Within set of sequential games are preemption games
• Being first to make a move may have certain advantages




Sometimes a player’s first move is to threaten other players
 We investigate consequences of idle threats
One game theory model explains why people will generally
drive their automobiles right through a green light
Another investigates Prisoner’s Dilemma game with
incomplete information
 Discuss possible mixed strategies for players to follow
As a final application of game theory, we discuss quid pro
quo
 Games are not resolved in isolation
5
The Game


Interaction among players is foundation of game theory
The game is a model representing strategic
interdependence of agents in a particular situation
 Strategic interdependence implies that optimal actions of a player
may depend on what he expects other players will do

Players are decision makers in game
 With ability to choose actions within a set of possible actions they
may undertake
 Players may be an individual or group of households, firms,
government, animals, or environment as a whole
 Number of players is finite
• Games are characterized by number of players (for example, a twoplayer or n-player game)
6
The Game

A game-theory model is composed of
 Players
 Rules by which game is played
• Rules involve what, when, and how game is played



What information each player knows before she moves (chooses
some action)
When a player moves relative to other players
How players can move (their set of choices)
 Outcome
 Payoffs
• Some reward or consequence of playing game

May be in form of a change in (marginal) utility, revenue, profit, or
some nonmonetary change in satisfaction
• Assumed that payoffs can at least be ranked ordinally in terms of
each player’s preferences
7
The Game

An example of a game is the children’s hand game: Rock, Paper,
Scissors
 Rules for game
• Each player simultaneously makes the figure rock, paper, or scissors with one of
their hands
 Outcome
• Rock dominates (crushes) scissors, scissors dominate (cut) paper, and paper
dominates (covers) rock



In a two-person game, player who makes dominating figure wins the game
When both make same figure, it’s a draw and neither player wins
Players each develop strategies for playing game
 Strategy (also called a decision rule) is set of actions a player may take
 Specifies how a player will act in every possible distinguishable
circumstance in which he may be placed
• For example, how a firm will react to a competitor’s possible price changes is
firm’s strategy for this competitor’s action

In general, a strategy is a player’s action plan
 In Rock, Paper, Scissors, strategy is the decision about when to form a rock,
paper, or scissors with one’s hand
8
The Game

A player’s strategy is his complete contingent
plan
 If it could be written down, any other agent could
follow the plan and duplicate player’s actions
 Thus, a strategy is a player’s course of action
involving a set of actions (moves) dependent on
actions of other players
• For instance with the game of chess, player develops
a specific set of actions for each possible move her
opponent could make

Actions implement a given strategy
9
The Game

Strategic form lists set of possible player strategies
and associated payoffs
 Table 14.1 shows strategic form for Rock, Paper,
Scissors
• Strategy pairs consist of combination of strategies from the two
agents
• If player F chooses rock and player R selects scissors


Strategy pair is (rock, scissors) with outcome that rock crushes
scissors
 Player F then wins and player R loses
Strategies and payoffs can be summarized in a
game matrix (a payoff matrix)
 Lists payoffs for each player given their strategies

In strategic form, only strategies are listed
10
Table 14.1 Strategic Form for the
Rock, Paper, Scissors Game
11
The Game

Extensive form provides an extended description of a game
 Reveals outcomes and payoffs from each set of player strategies
and possible actions each player can take in response to other
player’s moves

Game tree is used to represent extensive form of a game
 Illustrated in Figure 14.1 for Rock, Paper, Scissors
• Game is played from left to right


Each node (point) represents a player’s decision
 Connected by branches that indicate available actions a player
Extensive form of a game can be used to model everything
in strategic form plus information about sequence of actions
and what information each player has at each node
 Contains more detailed information
• May help eliminate some possible equilibrium outcomes
12
Figure 14.1 Game tree for Rock,
Paper, Scissors
13
The Game

For example, in Figure 14.1, two players F and R have the action choice
of making a rock, paper, or scissors
 If players move sequentially with player F moving first, player R can observe
player F’s action and always win
• If at initial decision node (also called a root) player F chooses rock


Player R—observing player F’s choice—will choose paper
 Yields terminal node with an associated payoff
 Player F loses and player R wins
Sequential moves put player who moves first at a disadvantage
 Other player will always choose an action that results in a win
 As a result of this disadvantage, player R will not reveal his action unless
player F also reveals her action
• When players thus simultaneously reveal their actions, neither player has any
prior information on the actions of the other player

In a game of simultaneous moves, game tree can be constructed with
either players’ actions at root
14
Equilibrium

Market equilibrium exists when there is no incentive for agents to
change their behavior
 Yields an equilibrium price and quantity

In game theory, a similar equilibrium may exist where players have no
incentives to change their strategy
 One equilibrium is called dominant strategy
• One strategy is preferred to another no matter what other players do
• When all players have a dominant strategy, an equilibrium of dominant strategies
exists that is determined without a player having to consider behavior of other
players


However, usually a player must consider other players’ strategies
 May then reduce his set of strategy choices based on rational behavior
By assuming all players are rational and attempting to maximizing utility,
a player determines a rationalizable strategy
 Generally, players who do not believe in rationalizable strategies will attempt
to maximize utility independent of other players
15
Equilibrium

A unique equilibrium or a set of equilibria may occur within a set of
strategies
 Called a Nash equilibrium (after mathematician John Nash)
• Each player’s selected strategy is his or her preferred response to strategies
actually played by all other players


Strategies are in a state of balance
An equivalent definition of a Nash equilibrium is where each player’s
belief about other players’ preferred strategies coincides with actual
choice other players make
 No incentive on part of any players to change their choices
 In a two-player game, a Nash equilibrium is a pair of player strategies where
strategy of one player is best strategy when other player plays his or her
best strategy

Not all games have a Nash equilibrium and some games may have a
number of Nash equilibria
16
Strategic Form


Strategic form of a game is a condensed version of extensive form
Actions with each player’s strategy are not reported in strategic form (how you
play is not reported)
 Only possible strategies of each player with associated payoffs (win or lose) are listed

Initially we assume that both players possess perfect knowledge
 Each player knows his own payoffs and strategies and other player’s payoffs and


strategies
Each player knows that other player knows this
In strategic form, a player’s decision problem is choosing his strategy given
strategies he believes other players will choose
 Players simultaneously choose their strategies, and payoff for each player is
determined
• For example, firms interacting within a market could compete in advertising or jointly advertise
in an effort to increase total demand for their products

In most economic situations, agents can jointly or independently influence total
payoff
 Indicates a possibility of cooperation or collusion
• Collusion is a joint strategy that improves position of all players
17
Strategic Form

An example of a strategic interaction among players is the
Battle-of-the-Sexes game
 Strategic form of this game is presented in Table 14.2
• Payoff matrix composed of (wife’s payoff, husband’s payoff)

Two players are a wife and husband deciding what to do on
a Saturday night
 Two choices: going to opera or to the fights
• If they both go to the opera (fights) they each receive some positive
utility

Wife’s (husband’s) level of satisfaction is higher than husband’s (wife’s)
• If husband goes to fights while the wife goes to the opera

They each enjoy their respective activity but not as much as if they went
together to either event
• If husband went to opera and wife to the fights

Both receive disutility
18
Table 14.2 Battle-of-the-Sexes
Game
19
Strategic Form


As shown in Table 14.2, sum of payoffs is higher in two
strategy pairs where they go together to same event
 Compared with each going to a different event
A result of payoffs is possibility of multiple Nash equilibria
 Both going to opera is a Nash equilibrium
• Because if either one picks fights instead their utility is decreased

For example, if husband picks fights, his utility is reduced from 2 to 1
 If wife picks fights, her utility falls from 5 to -7
 Both going to fights is a Nash equilibrium
• If either one instead picks opera, wife’s utility falls from 2 to 1 and
husband’s from 5 to -1

In general, even if a Nash equilibrium exists, it may not be
unique
 Problem of multiple Nash equilibria can be avoided when players
can choose a strategy mix
20
Prisoners’ Dilemma

In general, Prisoners’ Dilemma game is a situation where
two prisoners are accused of a crime
 D.A. does not have sufficient evidence to convict them
• Unless at least one of them supplies some supporting testimony


If one prisoner were to testify against the other, conviction
would be a certainty
D.A. offers each prisoner separately a deal
 If one confesses while his accomplice remains silent
• Talkative prisoner will receive only 1 year in prison
• Silent prisoner will be sent up for maximum of 10 years
 If neither confesses, both will be prosecuted on a lesser offense
 If both confess, in which case testimony of neither is essential to the
prosecution
• Both will be convicted of the major offense and sent up for 5 years

As shown in Table 14.3, payoff matrix is composed of (F’s
payoff, R’s payoff)
21
Table 14.3 Prisoners’ Dilemma
22
Prisoners’ Dilemma

Unique Nash equilibrium to Prisoners’ Dilemma is where each prisoner
confesses and each is sentenced to 5 years
 From Table 14.3, if prisoner R does not confess, prisoner F can increase her

payoff by confessing (reduced jail time by 1 year)
If prisoner R confesses, prisoner F will again confess and receive 5 fewer
years
• Thus, for prisoner F confessing is always preferred to not confessing



Confessing is dominant strategy for prisoner F
Confessing is also dominant strategy for prisoner R
Thus, Nash equilibrium is both confessing
 No other pair of strategies is in Nash equilibrium
• If prisoner F does not confess, she will receive 10 years, because prisoner R will
believe that if prisoner F confesses and he does not confess then he will receive
10 years


Thus, prisoner R will confess
Illustrates situation, common in economics, where cooperation (not
confessing) can improve welfare of all players
23
Prisoners’ Dilemma

Although dominant strategy of both confessing is Nash
equilibrium strategy
 It is not preferred outcome of players acting jointly
 Both prisoners would prefer that they jointly do not confess and each
receive only 2 years
• Classic example of rational self-serving behavior not resulting in a social
optimum

If the two prisoners could find a way to agree on the joint
strategy of not confessing and, of equal importance, a way to
enforce this agreement
 Both would be better off than when they play the game independently
• However, it is still in the interest of each prisoner to secretly break
agreement

One who breaks the deal and confesses will only receive 1 year while the other
will pay price of receiving an additional 8 years
 Example of a bilateral externality
24
Enforcement


In Prisoners’ Dilemma example, Nash equilibrium results in confession when
joint optimal solution would be for both prisoners to not confess
For this joint cooperation to result, some type of enforcement is required
 Otherwise, there is an incentive on part of at least one player to break agreement

Table 14.3 highlights difference between what is best from an individual’s point
of view and that of a collective
 Conflict endangers almost every form of cooperation

Reward for mutual cooperation is higher than punishment for mutual defection
 But a one-sided defection yields a temptation greater than that reward
• Leaves exploited cooperator with a loser’s payoff that is even worse than punishment for
mutual defection

Rankings from temptation through reward and punishment imply that the best
move is always to defect, irrespective of the opposing player’s move
 Leads to mutual defection unless some type of enforcement exists
25
Cooperation

In general, agents attempt to cooperate
 Agents defecting from cooperative agreements are usually not observed in
societies
 Agents often instead cooperate, motivated by feelings of solidarity or
altruism

In business agreements, defection is relatively rare
 Cooperation among agents in an economy may be as essential as
competition for economic efficiency and enhancing social welfare

A solution consistent with cooperation may result if Prisoners’ Dilemma
game is repeatedly played
 If one player chooses to defect in one round, then other player can choose


to defect in next round
In a repeated game, each player has opportunity to establish a reputation for
cooperation and encourage other player to cooperate
If a game is repeated an infinite number of times
• Cooperative strategy of not confessing may dominate single-game Nash
equilibrium of confessing
26
Cooperation

Consider first a finite number, T, of repeated games (a
finitely repeated game)
 Last round, T, is same as playing game once
• Solution will be the same and both players will defect by confessing
 In round (T - 1), there is no reason to cooperate since in round T they
both defected
• Thus, in round (T - 1) they both defect
• Defection will continue in every round unless there is some way to
enforce cooperation on last round

However, if game is repeated an infinite number of times (an
infinitely repeated game)
 Player does have a way of influencing other player’s behavior
• If one player refuses to cooperate this time, other player can refuse to
cooperate next time
27
Cooperation

Robert Axelrod identifies optimal strategy for an
infinitely repeated game as tit-for-tat (also called a
trigger strategy)
 On first round player F cooperates and does not confess
 On every round after, if player R cooperated on previous

round, F cooperates
• If R defected on previous round, F then defects
Strategy does very well because it offers an immediate
punishment for defection and has a forgiving strategy
• An application is the carrot-and-stick strategy that underlies most
attempts at raising children
28
Cooperation

An alternative strategy is win-stay/lose-shift
 If a player wins with a chosen strategy, she keeps same strategy for
next round
• If she loses, she changes to an alternative strategy
 Similar to tit-for-tat strategy in terms of preventing exploiters from
invading a cooperative society
• Will provide incentives for any exploiter to cooperate



Exploiters in a cooperative society are players who attempt to maximize
their payoff given strategies of other players
Does not matter to exploiters if their strategy results in cooperation or not
 Only interested in maximizing their payoff
However, this win-stay/lose-shift strategy fares poorly
among noncooperators
 Against persistent defectors a player employing win-stay/lose-shift
strategy tries every second round to resume cooperation
29
Sequential Games

In a sequential, or dynamic, game, one player knows other player’s
choice before she has to make a choice
 Many economic games have this structure
• For example, a monopolist can determine consumer demand prior to producing
an output, or a buyer knows sticker price on a new automobile before making an
offer

As an example of a sequential game, consider Battle-of-the-Sexes game
in Table 14.2
 Husband prefers going to fights and wife prefers opera
 However, they both prefer spending their leisure time together
• Results in two pure-strategy Nash equilibria (both going to the opera or both to
•
the fights) if both players reveal their choices simultaneously
Suppose husband chooses first and then wife

Game tree outlining this sequence of choices is illustrated in Figure 14.2
 Game tree is a description of game in extensive form
 Indicates dynamic structure of game, where some choices are made before
others
 Once a choice is made, players are in a subgame consisting of strategies and
payoffs available to them from then on
30
Figure 14.2 Game tree for Battleof-the- Sexes
31
Sequential Games

If husband picks opera, the subgame is for the wife to choose
 If she picks opera also, husband ends with a payoff of 2 and wife with a
payoff of 5

If husband picks fights, it is optimal for wife to also pick fights
 Resulting payoffs are 5 for husband and 2 for wife
• For husband (first player), 5 is greater than 2


So equilibrium for this sequential game is for couple to go to the fights
One of Nash equilibria in strategic form of the game, Table 14.2
 Both going to the fights is not only an overall equilibrium, but also an

equilibrium in each of the subgames
A Nash equilibrium with this property is known as a subgame perfect Nash
equilibrium
• Unique equilibrium of both going to the fights is conditional on who makes first
choice
32
Sequential Games

If instead wife made first move, alternative Nash equilibrium, both going to
the opera, would be unique solution of this sequential game
 Thus, this strategy pair of opera and fights is really a subset of a larger game
involving the strategies of moving first or second

Use a technique called backward induction to determine a subgame
perfect Nash equilibrium, by working backward toward the root in a game
tree
 Once game is understood through backward induction, players play it forward
 To apply backward induction, first determine optimal actions at last decision
nodes that result in terminal nodes
• Then determine optimal actions at next-to-last decision nodes, assuming that optimal
actions will follow at next decision nodes

Continue backward process until root node is reached
 Backward induction implicitly assumes that a player’s strategy will consist of
optimal actions at every node in game tree
• Called principle of sequential rationality

At any point in game tree, player’s strategy should consist of optimal actions from that point
on given other players’ strategies
33
Figure 14.3 Reduced game tree
for Battle-of- the-Sexes
34
Preemption Games


Battle-of-the-Sexes game illustrates advantage of moving first
In many economic game-theory models, firms who act first have an
advantage
 Called preemption gamesstrategic precommitments can affect future
payoffs
• For example, a firm adopting a relatively large production capacity in a new market
can saturate market and make it difficult for ensuing firms to enter


Any economies of scale associated with this production can be achieved with this large
capacity
 Firm moving first has potential of lower average production costs
Ability to seize a market first depends on market’s contestability
 If market is contestable, potential entrant firms can practice hit-and-run entry

• Will mitigate any advantages of moving first
Governments concerned with ability of firms to saturate a market and
forestall entry of other firms have attempted to place restrictions on such
behavior
 Example: President Reagan placed a 5-year tariff on motorcycles to rescue
domestic motorcycle company Harley-Davidson
35
Preemption Games

An example of a preemption game is provided in Table 14.4
 Firms 1 and 2 are faced with choice of entering or not entering a
market
 Market is not large enough for both to enter, so if they both enter
they will each experience losses in payoff of 5
• If neither firm enters, both payoffs are 0
 The two pure-strategy Nash equilibria are for one firm to enter and
the other not
• Whichever firm moves first and enters market will receive a positive
payoff of 10

Other firm will not enter and receive a 0 payoff
 Strategy for firms is to be first to enter market
• If one of the firms is a foreign firm and has some advantages of being
first to enter a domestic market


Domestic government may attempt to restrict that entry to enable domestic
firm to enter first
Once domestic firm enters, foreign firm no longer has an incentive to enter
36
Table 14.4 Preemption Game
37
Market Niches

Preemption games can also help us understand discount
stores’ location strategies
 In United States, small towns generally only have sufficient
populations to support one major discount store
 First discount firm to establish a store in town drives out any preexisting local nondiscount competition and has a local monopoly
• As country gets saturated with these discount stores, opportunities to
establish local monopolies decline

Discount firms will attempt to fill a market niche instead
 For example, Target stores cater to uppermiddle-income households
 Once a discount store enters a local market, existing nondiscount
stores will attempt to adjust their market in an effort to find a market
niche
• For nondiscount stores, price competing with a discount store is
generally not an optimal choice
38
Market Niches

As implied in Table 14.5, a chain of discount stores
will generally, by economies to scale, have lower
average costs than a single nondiscount store
 If nondiscount store attempts to compete by lowering its
price, discount store will also lower its price
• Results in losses for nondiscount store while discount store still
remains profitable
 Dominant strategy for nondiscount store is to maintain its
high price
• Strategy for discount firm is then to enter and offer slightly lower
prices than nondiscount store

Nondiscount store can then either develop a market niche around
discount store or eventually go out of business
39
Table 14.5 Discount Entry
40
Market Niches

In general, producers will attempt to occupy every market niche to keep
potential entrants from gaining access into a market
 Through research and development, a firm will endeavor to supply a complete
range of a particular product to cover every niche

Consider two firms entertaining entry into a market for a commodity, say,
breakfast cereals with two niches, sweet cereals, J, and healthy cereals H
 Payoff matrix is provided in Table 14.6
• If both firms move simultaneously, two Nash equilibria result

With each firm picking a different market niche
• Whichever firm moves first will capture preferred market niche and receive higher
payoff


To be first, the firm must make a commitment
 Either by actually providing product first or by advertising in advance that it will supply
product for preferred niche
If there are large sunk costs associated with this commitment, then the other firm (say, firm
2) will realize firm 1 is in fact committed to preferred product niche J
 Firm 2 may accede and supply in niche H
41
Table 14.6 Market Niches
42
Threats

Firm 1 could attempt to just threaten firm 2
 Instead of making a commitment to supply in preferred niche market
J and incurring sunk costs

For example, firm 1 could threaten firm 2 by stating it will
produce in niche J regardless of what firm 2 does
 However, firm 2 has to believe the threat to acquiesce
• One way to make a threat credible is to make commitment in sunk cost
• Or, firm 1 could simply mislead firm 2 into believing it is making a
commitment to niche J when in fact it is not


Assumes asymmetric information
Idle or empty threats will not succeed in inducing a player
to select some action
43
Threats

Consider two competing firms advertising
 Payoff matrix in Table 14.7 represents returns from firms’
choices of either advertising or not
• Pure-strategy Nash equilibrium is for firm 1 to advertise and firm
2 not to advertise
• Firm 1’s advertising has a relatively large impact on returns for
the two firms

In terms of advertising, firm 1 is dominant firm in industry
• Despite Firm 1’s dominance, firm 2’s advertising does positively
affect firm 1’s returns

By possibly expanding total market in which products are being
advertised
44
Table 14.7 Idle Threats
45
Threats

In this case, advertising is not drawing sales from one firm to another
 But instead is making product known to more consumers
• Enlarges both firms’ markets

Thus firm 1 would prefer that firm 2 also advertise
 However, added expense of advertising by firm 2 is not covered by its returns
• However, even considering dominance of firm 1, it cannot threaten to not
advertise in order to induce firm 2 into advertising



Because no matter which choice firm 2 makes, firm 1’s dominant strategy and its
subgame perfect Nash equilibrium is to advertise
Firm 2 will realize that if firm 1 is rational it will always advertise, so a threat of not
advertising by firm 1 is not credible
Subgame perfect Nash equilibrium results in a selection of a Nash
equilibrium obtained by removing strategies involving idle threats
 It is very important to always be willing and able to carry out a threat
46
Child Rearing

If one player derives satisfaction from penalizing the
other, threats made by player will be more credible
 The more credible the threat, the more likely it will be
acted upon

An example is child rearing
 Through reward and punishment, a parent derives

satisfaction of good behavior from a child
Figure 14.4 shows a game tree representing interactions
of a parent and child
• Child selects her behavior and parent chooses to reward or punish
it


Pure Nash equilibrium is a badly behaved child rewarded
Subgame perfect Nash equilibrium is for parent to always reward
47
Figure 14.4 A game tree for child
rearing
48
Child Rearing

If child believes parent will always reward any behavior, it will choose bad
behavior
 In contrast, if child is under impression that parent will punish bad behavior even if it
hurts parent
• Threat by parent will not be idle

In Figure 14.4, parent will not reward bad behavior even considering parent’s
payoff increases from 35 to 40
 Subgame perfect Nash equilibria are now for parent to reward good behavior and
punish bad
• Child will then realize bad behavior will result in punishment with an associated zero payoff
• Child will select good behavior over bad and increase her payoff from 0 to 15

In general, this example of parent/child interaction is a principal/agent model,
where principal is the parent and agent is the child
 Principal is attempting to provide incentives, both positive and negative, to elicit
correct behavior from agent
• In a repeated game, consistent behavior on the part of a principal can dominate inconsistent
behavior

For example, if a parent is consistent in following through with any threats
 Child will realize that probability of punishment for bad behavior is high and correct her bad
behavior
49
Child Rearing

Establishing a reputation of always being committed to any
threats can lead to cooperation by other player
 In Prisoners’ Dilemma game, an example of consistent behavior is
where a tit-for-tat strategy is consistently played
• Unless these incentives (threats) are taken seriously, agent will not
select principal’s desirable actions

For example, suppose a pro-business governor relaxes
regulatory constraints on small businesses by not enforcing
various environmental regulations
 Threat of enforcement exists, but it is an idle threat
• If a pro-environmental governor is later elected

Threat will become credible and firms will likely comply with regulations
50