Game Theory

Subgame Perfect Nash Equilibrium

Abhinash Borah

March 17, 2023

Sequential Rationality

Players ought to demonstrate rationality whenever they are called on to

make decisions. This is called sequential rationality.

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Sequential Rationality: Generalizing Backward Induction

A B

2
2,1
H T

1 1

H T H T

2 2
2,-2 2 2
2,-2 -2,2
22
-2,2

Abhinash Borah Subgame Perfection March 17, 2023 3 / 23

Sequential Rationality: Generalizing Backward Induction

A B

2
2,1
H T

1 1

H T H T

2 2
2,-2 2 2
2,-2 -2,2
22
-2,2

Backward induction cannot be applied in this game. But we can generalize its logic. Consider
the “subgame” starting after player 1 plays A. It is nothing but a matching pennies game which
has a unique mixed strategy Nash equilibrium under which both the players randomize
between H and T with probability .5 each that gives each player an expected payoff of 0.
Replace this subgame with its Nash equilibrium payoffs and perform backward induction on
the reduced tree.

Abhinash Borah Subgame Perfection March 17, 2023 3 / 23

Subgame

Given an extensive-form game, a node x in the tree is said to initiate a

subgame if neither x nor any of its successors are in an information set
that contains nodes that are not successors of x. A subgame is the tree
structure defined by such a node x and its successors.

That is, the information sets of the subgame are inherited from the
original game. Further, the payoffs of the subgame are also inherited
from the original game and the payoff function on the subgame is just the
restriction of the original payoff function to the terminal nodes of the
subgame. Therefore, subgames are self-contained extensive
forms—meaningful trees on their own. Subgames that start from nodes
other than the initial node are called proper subgames. Observe that in a
game of perfect information, every node initiates a subgame.

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Example—Subgames

A B

2
2,1
H T

1 1

H T H T

2 2
2,-2 2 2
2,-2 -2,2
22
-2,2

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Example—Subgames

A B

2
2,1
H T

1 1

H T H T

2 2
2,-2 2 2
2,-2 -2,2
22
-2,2

This game has two subgames: The game itself and the game consisting of the
node following 1 choosing A along with all its successor nodes
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Example—Subgames

A B

2
2,1
H T

1 1

H T H T

2 2
2,-2 2 2
2,-2 -2,2
22
-2,2

This game has two subgames: The game itself and the game consisting of the
node following the history A along with all its successor nodes
Abhinash Borah Subgame Perfection March 17, 2023 6 / 23
Example—Subgames

N1 [.5] [.5] N2
1
1
1
1 0
0
2 2

2
2

A R A R A R
A R

0,1
, 0,0 1,1 0,0 2,0 0,0
10
1,0 00
0,0

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Example—Subgames

N1 [.5] [.5] N2
1
1
1
1 0
0
2 2

2
2

A R A R A R
A R

0,1
, 0,0 1,1 0,0 2,0 0,0
10
1,0 00
0,0

The only subgame of this game is the game itself

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Example—Subgames
Subgame Perfection 189

FIGURE 15.3 E 3, 3, 6
Subgames. 1
y
A
2 F 1, 5, 7
x
G 2, 0, 3
U B 3
z

1 H 7, 7, 2

G 0, 6, 1

w
D C
2 H 8, 6, 0

D
6, 2, 4

To test your comprehension, examine the game in Figure 15.3. Note that this
game is a three-player game. The initial node initiates a subgame, because the
Abhinash Borah Subgame Perfection March 17, 2023 8 / 23
Example—Subgames
Subgame Perfection 189

FIGURE 15.3 E 3, 3, 6
Subgames. 1
y
A
2 F 1, 5, 7
x
G 2, 0, 3
U B 3
z

1 H 7, 7, 2

G 0, 6, 1

w
D C
2 H 8, 6, 0

D
6, 2, 4

To test your comprehension, examine the game in Figure 15.3. Note that this
This game has two subgames
game is a three-player game. The initial node initiates a subgame, because the
Abhinash Borah Subgame Perfection March 17, 2023 8 / 23
Subgame Perfect Nash Equilibrium

A subgame is a portion of an extensive game that can be analyzed as an

extensive game in its own right. In particular, conditional on a subgame
being reached, payoffs in it are well defined

Since payoffs in any subgame are well defined we can test whether
strategies yield a Nash equilibrium when restricted to the subgame in the
obvious way.

DEFINITION
A strategy profile is called a subgame perfect Nash equilibrium (SPNE) if it
specifies a Nash equilibrium in every subgame of the original game

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SPNE: Remarks

An SPNE is a Nash equilibrium because such a profile must specify a

Nash equilibrium in every subgame, one of which is the entire game. We
thus speak of SPNE as a refinement of Nash equilibrium.

For extensive games of perfect information, backward induction yields

SPNE

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Example: Subgame Perfect Nash Equilibrium

D
U

2,2

L R

3,1 0,0

(D, L) is the unique SPNE

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 Example: Subgame Perfect Nash Equilibrium

Sequential Rationality and Subgame Perfection

URE 15.4 X 3, 4
2
game perfection. A
1 Y 1, 4
U X
1 2, 1
B
D Y 2, 0
2, 6
2 2
1 X Y 1 X Y
UA 3, 4 1, 4 A 3, 4 1, 4
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Example: Subgame Perfect Nash Equilibrium

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Example: Subgame Perfect Nash Equilibrium

A B

2
2,1
H T

1 1

H T H T

2 2
2,-2 2 2
2,-2 -2,2
22
-2,2

β1∗ = (B, [H, .5; T, .5]), β2∗ = [H, .5; T, .5] is the unique SPNE
Abhinash Borah Subgame Perfection March 17, 2023 14 / 23
Behavioral Strategies

When under a player’s strategy, she mixes between the available actions
at any of her information sets, we refer to her strategy as a behavioral
strategy. In other words, a behavioral strategy of a player specifies for
each of her information sets an independent probability distribution over
the available actions at that information set. Therefore, pure strategies in
the extensive form can be thought of as a special case of behavioral
strategies.

Connection with mixed strategies

It can be shown that in any extensive form game with perfect recall, the
two types of randomization—mixed and behavioral—are equivalent
from a strategic point of view. Which form of randomized strategies we
consider is therefore a matter of analytical convenience. Game theorists
typically use behavioral strategies when analyzing the extensive form.
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Example: Subgame Perfect Nash Equilibrium
N

N1 [.5] [.5] N2
1
1
1
1 0
0
2 2

2
2

A R A R A R
A R

0,1
, 0,0 1,1 0,0 2,0 0,0
10
1,0 00
0,0

(s∗1 , s∗2 ) = ((0, 0), (A, A)) is a pure strategy SPNE

Are there other pure strategy SPNE?
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Example: SPNE in Stackelberg Duopoly
Firm 1 decides first and then firm 2 decides (after observing 1’s choice) how
much quantity of a homogenous product to produce in a market with demand
func. P = 100 − Q, when each firm has cost of production given by c(q) = q2 .

The unique SPNE is:

q1
q∗1 =
e 150
7 q∗2 (q1 ) = 25 −
and e 4

Compare equilibrium profits of the two firms here with that of the two
firms (with same cost function and facing same market demand as here)
under Cournot Duopoly

Abhinash Borah Subgame Perfection March 17, 2023 17 / 23

Example: Bargaining

Bargaining problem within a simple framework

Two players, 1 and 2, need to split a “pie” (representing, say, the surplus
from an agreement or the gains from trade)

The pie is assumed to have a total value that is normalized to equal 1

We will assume throughout that the players care only about their share of
the pie and their utility from receiving x of the pie is given by u(x) = x

In order to systematically study this problem we need to specify the

bargaining protocol: who can do what and when; and how these translate
into outcomes?

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One Round of Bargaining: The Ultimatum Game

One of the players, say 1, offers to give m of the pie of the other player
player, 2. That is, she proposes a split of (1 − m, m) of the pie between
herself and the other player. Player 2 after observing the proposal, either
accepts or rejects the proposal. If she accepts, then the pie is split
between the two players according to the proposal. If she rejects both
players receive nothing.

We can represent this strategic environment as an extensive game. Please

do so.

Specify what the set of all strategies of the two players are

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One Round of Bargaining: The Ultimatum Game

What is the set of Nash equilibria of the extensive game you formulated
above? What are the set of payoffs that can be supported as Nash equilibrium
payoffs?

Abhinash Borah Subgame Perfection March 17, 2023 20 / 23

One Round of Bargaining: The Ultimatum Game

What is the set of Nash equilibria of the extensive game you formulated
above? What are the set of payoffs that can be supported as Nash equilibrium
payoffs?

PROPOSITION
Any split of the pie can be supported as Nash equilibrium payoffs in the
ultimatum game. Formally, the set of payoffs that can be supported as Nash
equilibrium payoffs is:

V = {(1 − m, m) : m ∈ [0, 1]}

Abhinash Borah Subgame Perfection March 17, 2023 20 / 23

One Round of Bargaining: The Ultimatum Game

What is the set of subgame perfect Nash equilibria (SPNE) of the extensive
game you formulated above? What are the set of payoffs that can be
supported as SPNE payoffs?

Abhinash Borah Subgame Perfection March 17, 2023 21 / 23

One Round of Bargaining: The Ultimatum Game

What is the set of subgame perfect Nash equilibria (SPNE) of the extensive
game you formulated above? What are the set of payoffs that can be
supported as SPNE payoffs?

PROPOSITION
The ultimatum game admits a unique SPNE in which player i offers m = 0
and player j accepts any offer.

Abhinash Borah Subgame Perfection March 17, 2023 21 / 23

Subgame Perfection—Critical Assessment

Centipede Game: There are two players, 1 and 2. The players each start
with INR 1000 in front of them. They alternate saying “stop” (S) or
“continue” (C), starting with player 1. When a player says C, INR 1000
is taken by a referee from her pile and INR 2000 is put in her opponent’s
pile. As soon as either player says S, play is terminated, and each player
receives the money currently in her pile. Alternatively, play stops if both
players’ pile reach INR 100000.

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Subgame Perfection—Critical Assessment

Centipede Game
1
S C
2
1,1
S C
1
0,3 S C

2,2

2
S C
1
C
97,100 S 2

99,99 S C

98,101 100,100

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Subgame Perfection—Critical Assessment

Centipede Game
1
S C
2
1,1
S C
1
0,3 S C

2,2

2
S C
1
C
97,100 S 2

99,99 S C

98,101 100,100

The unique SPNE of this game has both players playing S whenever it is their
turn and the players each receive INR 1000 in this equilibrium. Is this a
reasonable prediction?
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