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Backward Induction

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9 views

Backward Induction

Uploaded by

rkesav2004
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Backward induction

Backward induction
• Backward induction is the primary method for solving
sequential games, particularly when they are finite.
• Backward Induction Process:
1.Start at the end of the game: Identify the final possible
decisions in the game.
2.Determine the optimal action for the last player: For each
possible decision at the last stage, choose the one that
maximizes the final player's payoff.
3.Work backward step by step: Move to the previous
decision points (those right before the final move). Knowing
how the last player will act, determine the optimal decision
for the player making the choice at this stage.
4.Continue backward until the first decision is reached:
Repeat this process until you reach the very first decision
point in the game. By then, you'll have determined the best
move at each stage of the game.
Example
• There are two players, A and B, make sequential decisions.
• First, A chooses between two actions: Action 1 and Action 2.
• Then, based on A's decision, B makes a choice between
Action 3 and Action 4.
• Each combination of choices leads to a certain outcome,
which gives specific payoffs to both players.
• Using backward induction, you would:
• Look at B’s possible choices (Action 3 and Action 4) and
determine which gives B the highest payoff, assuming A has
already made their choice.
• Then, move to A’s choice. Knowing how B will respond to
each of A’s possible actions, A can choose the action that
gives them the highest payoff.
• This process ensures both players are acting rationally,
assuming they have perfect information about previous
decisions and are optimizing their payoffs
Key Assumptions of Backward
Induction:
• Perfect Information: Every player knows all
previous actions when making a decision.
• Rationality: Each player is rational and seeks to
maximize their own payoff.
• Finite Game: The game has a finite number of stages
and possible outcomes, which allows backward
induction to function.
Example: Bargaining Over a
$10 Bill
• Scenario
• Two players, A and B, are bargaining over how to split $10.

• Player A makes the first move by proposing how much of


the $10 to keep and how much to give to Player B.
• Player B can either accept or reject A’s offer.

• If Player B accepts, the split happens as proposed. If Player


B rejects, neither player gets any money.
Game Tree
1. Initial Decision (Player A):
o
Player A can choose how much to offer B (for
simplicity, A can offer $5 or $2).
o
If A offers $5, A keeps $5 and B gets $5.
o
If A offers $2, A keeps $8 and B gets $2.

2. Player B’s Response:


o
After A’s offer, B can either accept or reject the offer.
o
If B accepts, the split happens as proposed.
o
If B rejects, both get nothing ($0 each).
Example: Bargaining Over a $10 Bill
A

Offer$5 Offer $2
B B
B Accept B Reject B Accept B Reject
(A: $5,B: $5) (A:$0,B:$0) (A:$8,B:$2) (A:$0,B:$0)
Backward Induction Process
1. Start at the End of the Game (Player B’s Decision):
o
If A offers $5:

B can accept and get $5 (A also gets $5).

B can reject and get $0 (A also gets $0).

Since $5 > $0, B will accept this offer.
o
If A offers $2:

B can accept and get $2 (A gets $8).

B can reject and get $0 (A also gets $0).

Since $2 > $0, B will accept this offer as well.
2. Work Backward to Player A’s Decision:
o
Knowing that Player B will accept any positive offer, Player A now
chooses their offer.
o
Player A calculates their payoff:

If A offers $5, A gets $5 (B gets $5).

If A offers $2, A gets $8 (B gets $2).
o
Since $8 > $5, Player A will choose to offer $2, knowing that
Player B will accept it.

•Final Outcome:

Player A offers $2.


Player B accepts the offer.


The final outcome is: A gets $8, B gets $2.



Explanation with Backward
Induction
• In backward induction, Player A reasoned through
Player B's response to different offers. A knows that B
will accept any positive offer because receiving some
money is better than receiving nothing. Thus, A decides
to offer $2, which maximizes A’s own payoff, knowing
B will accept it.
• The key idea here is that the game is solved by looking
ahead to B’s decisions (accept/reject) and reasoning
backward to determine A’s optimal strategy. This
process ensures that each player is acting rationally at
every stage of the game.
General Insights from the Example
• Perfect Information: Both A and B know exactly what
decisions have been made when they act. B knows A’s
offer, and A can predict how B will respond to each offer.
• Sequential Decision-Making: First, A moves, and then B
responds. This sequential structure is what allows
backward induction to work.
• Rationality: Both players are assumed to act rationally,
meaning that B will always choose the option that
maximizes their payoff.
• In real-life situations like bargaining, chess, or legal
negotiations, backward induction helps players anticipate
how others will act and make the best possible decisions
accordingly.

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