Lecture notes 1 - Lecture 1 Foundations This lecture...

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Economics 112 Lecture Notes Lecture 1. Foundations This lecture introduces the basic elements required to formally study games. The elements combine to form models of strategic situations. The models, when correctly designed and analyzed, can clarify the messy complexity of most situations. On occasion, casting a situation in the language of game theory can dramatically revise your understanding. Even when the models do little more than formalize your intuitions, they are extremely helpful when you attempt to talk about strategic situations with other people. For this reason, the language of game theory is widely employed in the social sciences and elsewhere. As will be apparent below, the value of these tools depends crucially on getting some basic assumptions correct, and it is not always the case that these assumptions can be easily “read from reality”, that is, based on confirmable facts about the world. What distinguishes a good from a poor game theorist is largely how well these basic modeling choices are made. Well chosen assumptions lead to a tractable (i.e. feasibly solvable) model that captures the important features of the situation under study. Of course, good game theorists are also generally skillful solvers of games, and this is sometime not easy. But many extremely useful games are not hard to solve, once specified correctly. The worst situation is a poorly chosen set of assumptions, analyzed wrongly. This is more common than it should be. For now we will focus on building models of games. In the next lecture we will see how these can be solved. Key terms: Choice, ordinal payoff, strategy, extensive form, normal (strategic) form. Additional key terms are noted by bold font . 1. Choice Theory A model of choice links a set of choices or actions to a set of outcomes (or consequences) . The link may be deterministic , where each choice leads with certainty one particular outcome, or stochastic , where chance intervenes to help determine the outcome. In simple choice theory we ignore strategic considerations and assume that no other decision-makers are involved. Sometimes, however, we speak as if the element of chance were a choice made by nature , as if nature was an actor. In such cases, we assume that nature is not motivated by any interest in the outcome. Example: Do you have another cup of coffee? Actions: another cup, not another cup. Consequences: if you have another cup, you have some pleasure, perhaps, and face financial, time and possible health costs; if you don’t you forego pleasure, possibly, but avoid those negative costs. This may be entirely deterministic, or you may believe that 15 minutes more or less at the lunch counter in Schwab’s Pharmacy (okay, Starbucks) can change your life forever. Similarly, you might think the correct model is stochastic if you have never had a cup of coffee before.
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This note was uploaded on 01/28/2011 for the course ECON 112 taught by Professor Notsure during the Winter '08 term at University of Victoria.

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Lecture notes 1 - Lecture 1 Foundations This lecture...

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