|
June 26, 1993. Small changed, August 18, 1993. April 30, 1999
Eric Rasmusen, [email protected]1
1xxx Footnotes starting with xxx are the author's notes to himself.
Comments are very much welcomed.
Preface
Contents and Purpose
This book is about noncooperative game theory and asymmetric information. In the
Introduction, I will say why I think these subjects are important, but here in the Preface
I will try to help you decide whether this is the appropriate book to read if they do
interest you.
I write as an applied theoretical economist, not as a game theorist,
and readers in anthropology, law, physics, accounting, and management science have helped
me to be aware of the provincialisms of economics and game theory. My aim is to present
the game theory and information economics that currently exists in journal articles and
oral tradition in a way that shows how to build simple models using a standard format.
Journal articles are more complicated and less clear than seems necessary in retrospect;
precisely because it is original, even the discoverer rarely understands a truly novel
idea. After a few dozen successor articles have appeared, we all understand it and marvel
at its simplicity. But journal editors are unreceptive to new articles that admit to
containing exactly the same idea as old articles, just presented more clearly. At best,
the clarification is hidden in some new article's introduction or condensed to a paragraph
in a survey. Students, who find every idea as complex as the originators of the ideas did
when they were new, must learn either from the confused original articles or the oral
tradition of a top economics department. This book tries to help.
Changes in the Second Edition, 1994
By now, just a few years later after my first edition, those trying to learn game
theory have more to help them than just this book, and I will list a number of excellent
books below. I have also thoroughly revised Games and Information. George Stigler
used to say that it was a great pity Alfred Marshall spent so much time on the eight
editions of Principles of Economics that appeared between 1890 and 1920, given
the opportunity cost of the other books he might have written. I am no Marshall, so I have
been willing to sacrifice a Rasmusen article or two for this new edition, though I doubt I
will keep it up till 2019.
Games and Information has been a more successful book than either my
publisher or I expected, selling well throughout the world and appearing already in
Italian and Japanese translations. When I was in graduate school, I and many other
students studying econometrics found the subject difficult enough that even though the
assigned texts were not badly written, we were driven to look for other books on the
subject. Kennedy (1979) and Maddala (1977) were two books that I never heard of being
assigned for a course, but which were commonly read by graduate students. Games and
Information has done well in this respect, which, given the principal-agent problems
it discusses, is more flattering than its sales as an assigned text. Given this success, I
have not changed the style or organization of the book.
What I have done for the second edition is to add a number of new
topics, increase the number of exercises (and provide detailed answers), update the
references, change the terminology here and there, and rework the entire book for clarity.
A book, like a poem, is never finished, only abandoned (which is itself a good example of
a fundamental economic principle). The one section I have dropped is the somewhat
obtrusive discussion of existence theorems; I recommend Fudenberg & Tirole (1991) on
that subject. The new topics include auditing games, nuisance suits, recoordination in
equilibria, renegotiation in contracts, supermodularity, signal jamming, market
microstructure, and government procurement. The discussion of moral hazard has been
reorganized. The total number of chapters has increased by two, the topics of repeated
games and entry having been given their own chapters.
Changes in the Third Edition, 1999
Besides numerous minor changes in wording, I have added certain material and
reorganized some sections of the book.
The new topics are 9A.5 Setting up a Way to Bargain: The
Myerson-Satterthwaite Mechanism; 9A.7 Price Discrimination; 12.3 Risk and Uncertainty over
Values [ in private-value auctions]; A.6 Fixed-Point Theorems; and A.7 Genericity.
To accommodate the additions, I have dropped Section 9.5 Other
Equilibrium Concepts: Wilson Equilibrium and Reactive Equilibrium (which is still
available on the book's website, however), and Appendix A, the answers to odd-numbered
problems. These answers are very important, but I have moved them to the website because
most readers who care to look at them will have web access and problem answers are
peculiarly in need of updating. Ideally, I would like to discuss all likely wrong answers
as well as the right answers, but I learn the wrong answers only slowly, with the help of
new generations of students.
Chapter 15: The New Industrial Organization has been eliminated and its
sections reallocated. Section 15.1: Why Established Firms Pay Less for Capital: The
Diamond Model is now Section 6.6; Section 15.2 Takeovers and Greenmail is now Section
14.2; Section 15.3 Market Microstructure and the Kyle Model is now Section 9.7; and
Section 15.4 Rate of Return Regulation and Government Procurement is now Section 9A.4.
Chapter 9A Mechanism Design in Adverse Selection and in Moral Hazard
with Hidden Information is new. I have labelled it "9A" so as to preserve the
old numbering of the later chapters, for the convenience of those familiar with the Second
Edition. It includes three sections from Chapter 8 (8.1 Pooling versus Separating
Equilibrium and the Revelation Principle is now Section 9A.1; 8.2 An Example of Moral
Hazard with Hidden Knowledge: The Salesman Game is now Section 9A.2; 8.5 Tournaments is
now Section 9A.3) and one from Chapter 9 (9.6 The Groves Mechanism is now Section 9A.6).
Topics that have been extensively reorganized or rewritten include 13.2
Prices as Strategies: Bertrand Equilibrium; 13.3 Location Models; the Mathematical
Appendix, and the Bibliography. Section 4.5 Discounting is now in the Mathematical
Appendix; 4.6 Evolutionary Equilibrium: The Hawk-Dove Game is now Section 5.6; 7.5
State-Space Diagrams: Insurance Games I and II is now Section 8.4, the sections in Chapter
8 are reordered; 14.2 Signal Jamming: Limit Pricing is now Section 10.6.
Some readers preferred the first edition to the second because they
thought the extra topics in the second edition made it more difficult to cover. To help
with this problem, I have now starred the sections that I think are most skippable. For
reference, I want to have those sections close to where the subjects are introduced, even
though they can be skipped by those first learning the material.
The two most novel features of the book are not contained within its
covers. One is the website, at Http://www.bus.indiana.edu/~erasmuse/book/
The website includes answers to the odd-numbered problems, new
questions and answers, errata, files from my own teaching suitable for making overheads,
and anything else I think might be useful to readers of this book.
The second new feature is a Reader-- essentially a prettified version
of the course packet I use when I teach this material. This is available from Blackwell
Publishing, and contains scholarly articles, news clippings, and cartoons arranged to
correspond with the chapters of the book. I have tried especially to include material that
is somewhat obscure or hard to locate, rather than just to make the reader a collection of
classic articles from leading journals.
Using the Book
The book is divided into three parts: Part I on game theory; Part II on information
economics; and Part III on applications to particular subjects. Parts I and II, but not
III, are ordered sets of chapters.
Part I by itself would be appropriate for a course on game theory, and
sections from Part III could be added for illustration. If students are already familiar
with basic game theory, Part II can be used for a course on information economics. The
entire book would be useful as a secondary text for a course on industrial organization. I
teach material from every chapter in a semester-long course for first and second-year
doctoral students at Indiana University School of Business, including more or fewer
chapter sections depending on the progress of the class.
Exercises and notes follow the chapters. It is useful to supplement a
book like this with original articles, but I leave it to my readers or their instructors
to follow up on the topics that interest them rather than recommending particular
readings. I also recommend that readers try attending a seminar presentation of current
research on some topic from the book; while most of the seminar may be incomprehensible,
there is a real thrill in hearing someone attack the speaker with "Are you sure that
equilibrium is perfect?" after just learning the previous week what
"perfect" means.
Some of the exercises at the end of each chapter put slight twists on
concepts in the text while others introduce new concepts. Answers to odd-numbered
questions are given at the end of the book. I particularly recommend working through the
problems for those trying to learn this material without an instructor.
The endnotes to each chapter include substantive material as well as
references. Unlike the notes in many books, they are not meant to be skipped, since many
of them are important but tangential, and some qualify statements in the main text. Less
important notes supply additional examples or list technical results for reference. A
mathematical appendix at the end of the book supplies technical references, defines
certain mathematical terms, and lists some items for reference even though they are not
used in the main text.
The Level of Mathematics
In surveying the prefaces of previous books on game theory, I see that advising readers
how much mathematical background they need exposes an author to charges of being out of
touch with reality. The mathematical level here is about the same as in Luce & Raiffa
(1957), and I can do no better than to quote the advice on page 8 of their book:
Probably the most important prerequisite is that ill-defined quality: mathematical
sophistication. We hope that this is an ingredient not required in large measure, but that
it is needed to some degree there can be no doubt. The reader must be able to accept
conditional statements, even though he feels the suppositions to be false; he must be
willing to make concessions to mathematical simplicity; he must be patient enough to
follow along with the peculiar kind of construction that mathematics is; and, above all,
he must have sympathy with the method--- a sympathy based upon his knowledge of its past
sucesses in various of the empirical sciences and upon his realization of the necessity
for rigorous deduction in science as we know it.
If you do not know the terms "risk averse," "first
order condition," "utility function," "probability density," and
"discount rate," you will not fully understand this book. Flipping through it,
however, you will see that the equation density is much lower than in first-year graduate
microeconomics texts. In a sense, game theory is less abstract than price theory, because
it deals with individual agents rather than aggregate markets and it is oriented towards
explaining stylized facts rather than supplying econometric specifications. Mathematics is
nonetheless essential. Professor Wei puts this charmingly in his informal and unpublished
class notes:2
"My experience in learning and teaching convinces me that going
through a proof (which does not require much mathematics) is the most effective way in
learning, developing intuition, sharpening technical writing ability, and improving
creativity. However it is an extremely painful experience for people with simple mind
and narrow interests."
"Remember that a good proof should be smooth in the sense
that any serious reader can read through it like the way we read Miami Herald;
should be precise such that no one can add/delete/change a word---like the way we
enjoy Robert Frost's poetry!"
I wouldn't change a word of that.
2xxx Have an RA track him down so I can ask him for premission to
quote him in this way.
Other Books
At the time of the first edition of this book, most of the topics covered were absent
from existing books on either game theory or information economics. Older books on game
theory include Harsanyi (1977), Luce & Raiffa (1957), Moulin (1986a, b), Ordeshook
(1986), Rapoport (1970), Shubik (1982), Szep & Forgo (1985), Thomas (1984), and
Williams (1966). Books on information in economics were mainly concerned with
decisionmaking under uncertainty rather than asymmetric information. Exceptions include
Bamberg & Spremann (1987) on agency theory, Hess (1983) on organization, and J. Green
& Laffont (1979) on mechanism design. Binmore & Dasgupta (1986), Diamond &
Rothschild (1978), and the immense Rubinstein (1990) are collections of key articles in
the game theory and information economics literature. For articles from the prehistory of
mathematical economics, see the collection by Baumol & Goldfeld (1968).
Since the first edition, a spate of books on game theory have appeared,
and I have come across a few others that I had earlier missed. I will list and not try to
summarize the books in this recent generation, but I recommend the one-sentence reviews in
the introduction of Binmore (1992). The stream of new books has become a flood, and I only
wish I could say I had been able to incorporate all the good ideas of my competitors into
the present edition.
Some Books on Game Theory and its Applications3
Fudenberg, Drew & Jean Tirole Dynamic Models of Oligopoly. Chur,
Switzerland: Harwood Academic Publishers, 1986.
McMillan, John, Game Theory in International Economics. Chur, Switzerland:
Harwood Academic Publishers, 1986.
Phlips, Louis, The Economics of Imperfect Information. Cambridge: Cambridge
University Press, 1988.
Tirole, Jean, The Theory of Industrial Organization. Cambridge, Mass: MIT
Press, 1988.
Schmalensee, Richard & Robert Willig, editors, The Handbook of Industrial
Organization. New York: North-Holland, 1989.
Eatwell, John, Murray Milgate & Peter Newman, eds, The New Palgrave: Game
Theory. New York: Norton, 1989.
Friedman, James, Game Theory with Applications to Economics. Oxford: Oxford
University Press, 1990. (First edition, 1986.)
Banks, Jeffrey, Signalling Games in Political Science. Chur, Switzerland:
Harwood Publishers, 1990.
Kreps, David, A Course in Microeconomic Theory. Princeton: Princeton
University Press, 1990.
Kreps, David, Game Theory and Economic Modeling. Oxford: Oxford University
Press, 1990.
Krouse, Clement, Theory of Industrial Economics. Oxford: Blackwell Publishers,
1990.
Dixit, Avinash K. & Barry J. Nalebuff, Thinking Strategically: The Competitive
Edge in Business, Politics, and Everyday Life. New York: Norton, 1991.
Laffont, Jean-Jacques and Michel Moreaux, editors, translated by Francois Laisney, Dynamics,
Incomplete Information, and Industrial Economics. Oxford: Blackwell Publishing, 1991.
Milgrom, Paul and John Roberts, Economics of Organization and Management.
Englewood Cliffs, New Jersey: Prentice-Hall, 1991.
Myerson, Roger Game Theory: Analysis of Conflict. Cambridge, Mass.: Harvard
University Press, 1991.
Fudenberg, Drew & Jean Tirole, Game Theory. Cambridge, Mass: MIT Press,
1991.
Aumann, Robert & Sergiu Hart, Handbook of Game Theory with Economic
Applications. Amsterdam: North-Holland, 1992.
Binmore, Ken, Fun and Games: A Text on Game Theory. Lexington, Mass.: D.C.
Heath, 1992.
Gibbons, Robert, {\it Game Theory for Applied Economists}. Princeton: Princeton
University Press, 1992.
McMillan, John, Games, Strategies, and Managers: How Managers can use Game Theory
to Make Better Business Decisions. Oxford, Oxford University Press, 1992.
Varian, Hal, Microeconomic Analysis. Third edition. New York: Norton, 1992.
(1st edition, 1978; 2nd edition, 1984.)
Laffont, Jean-Jacques & Jean Tirole, A Theory of Incentives in Procurement and
Regulation, Cambridge: MIT Press, 1993.
Basu, Kaushik, Lectures in Industrial Organization Theory. Oxford: Blackwell
Publishers, 1993.
Eichberger, Jurgen, Game Theory for Economists. San Diego: Academic Press,
1993.
Baird, Douglas, Robert Gertner & Randal Picker, Strategic Behavior and the Law:
The Role of Game Theory and Information Economics in Legal Analysis. Cambridge,
Mass.: Harvard University Press, 1994.
Morris, Peter, Introduction to Game Theory. Berlin: Springer Verlag,1994.
Osborne, Martin and Ariel Rubinstein, A Course in Game Theory. Cambridge:
Mass: MIT Press, 1994.
Morrow, James, Game theory for Political Scientists. Princeton, N.J. :
Princeton University Press, 1994.
Gardner, Roy, Games for Business and Economics. New York: John Wiley and Sons,
1994.
Mas-Colell, Andreu Michael D. Whinston and Jerry R. Green, Microeconomic Theory.
Oxford: Oxford University Press, 1995.
Taylor, Alan, Mathematics and Politics : Strategy, Voting, Power and Proof.
Berlin: Springer Verlag, 1995.
Owen, Guillermo, Game Theory. New York: Academic Press, 3rd edition, 1995.
(1st edition, 1968; 2nd edition, 1982.)
Damme, Eric van, Game Theory : The Next Stage. Tilburg, Netherlands : Center
for Economic Research, Tilburg University, 1995.
Scott Gates and Brian D. Humes, Games, Information, and Politics: Applying Game
Theoretic Models to Political Science. Ann Arbor: University of Michigan Press, 1996.
Besanko, David, David Dranove and Mark Shanley, Economics of Strategy, New
York: John Wiley and Sons, 1996.
Shy, Oz, Industrial Organization, Theory and Applications. Cambridge, Mass:
MIT Press, 1996.
Romp, Graham, Game Theory: Introduction and Applications. Oxford : Oxford
University Press, 1997.
Ghemawat, Pankaj, Games Businesses Play : Cases and Models. Cambridge, Mass.:
MIT Press, 1997.
Macho-Stadler, Ines and J. David Perez-Castillo, An Introduction to the Economics
of Information: Incentives and Contracts, Oxford: Oxford University Press, 1997.
Stahl, Saul, A Gentle Introduction to Game Theory. Providence, RI : American
Mathematical Society, 1998.
Bierman, H. Scott & Luis Fernandez, Game Theory with Economic Applications.
Reading, Massachusetts: Addison Wesley, 2nd edition 1998. (1st edition, 1993.)
Dugatkin, Lee and Hudson Reeve, editors, Game Theory & Animal Behavior.
Oxford : Oxford University Press, 1998.
Dixit, Avinash and Susan Skeath, Games of Strategy. xxx New York: Norton,
1999.
Muthoo, Abhinay, Bargaining Theory With Applications. Cambridge: Cambridge
University Press, 1999.
Dutta, Prajit, Strategies and Games: Theory And Practice. Cambridge, Mass: MIT
Press, 1999.
Gintis, Herbert, Problems in Game Theory, March 1998 manuscript.
Rasmusen, Eric Games and Information. Oxford: Blackwell Publishers, 3rd
edition, 1999. (1st edition, 1989; 2nd edition, 1994.)
3xxx Better: Put in headings by year of output.
Contact Information
The website for the book is at Http://www.bus.indiana.edu/~erasmuse/book/
This site has the answers to the odd-numbered problems at the end of
the chapters. For even-numbered questions, instructors or others needing them for good
reasons should email me at [email protected];
send me snailmail at Eric Rasmusen Department of Business Economics and Public Policy,
Kelley School of Business, Indiana University, 1309 East 10th Street, Bloomington, Indiana
47405-1701; or fax me at (812)855-3354.
If you wish to contact the publisher of this book, the American address
is Blackwell Publishers, 238 Main Street, Cambridge, Mass. 02142, telephone: (617)
547-7110, fax: (617) 547-0789, e-mail: [email protected].
The text files on the website are two forms (a) *.te, LaTeX, which uses
only ASCII characters, but does not have the diagrams, and *.pdf, Adobe Acrobat, which is
formatted and can be read using a free reader program. I encourage readers to submit
additional homework problems as well as errors and frustrations. They can either be put in
the guest file, or sent to me by Internet e-mail at [email protected].
Acknowledgements
I would like to thank Dean Amel, Dan Asquith, Sushil Bikhchandani, Patricia Hughes
Brennan, Paul Cheng, Luis Fernandez, David Hirshleifer, Jack Hirshleifer, Steven Lippman,
Ivan Png, Benjamin Rasmusen, Marilyn Rasmusen, Ray Renken, Richard Silver, Yoon Suh, Brett
Trueman, Barry Weingast and students in Management 200a from Spring 1985 to Spring 1989.
D. Koh, Jeanne Lamotte, In-Ho Lee, Loi Lu, Patricia Martin, Timothy Opler, Sang Tran, Jeff
Vincent, Tao Yang, Roy Zerner, and especially Emmanuel Petrakis helped me with research
assistance at one stage or another.
I would also like to thank Robert Boyd (UCLA), Mark Ramseyer (Harvard),
Ken Taymor, and John Wiley (UCLA) for their regular comments as each chapter of the first
edition was written.
Jonathan Berk, Mark Burkey, Craig Holden (Indiana), Peter Huang,
Michael Katz, Thomas Lyon (Indiana), Steve Postrel, Herman Quirmbach (Iowa State), H.
Shifrin, George Tsebelis (UCLA), Thomas Voss, and Jong-Shin Wei made useful comments on
sections of the second edition, and Alexander Butler (Louisiana State) and An-Sing Chen
provided research assistance. My students in Management 200 at UCLA and G601 at Indiana
University provided invaluable help, especially in suffering through the first drafts of
the homework problems.
Kyung-Hwan Baik (Sung Kyun Kwan U.), Patrick Chen, Mathias Erlei (U.
Muenster), Francisco Galera, Peter-John Gordon (University of the West Indies), Erik
Johannessen, Michael Mesterton-Gibbons, David Rosenbaum, Richard Tucker, Hal Wasserman (U.
Cal., Berkeley), and Chad Zutter made comments that were helpful for the third edition.4
4xxx Have an RA track down where all these people are to get their
current affiliations.
Eric Rasmusen
Professor of Business Economics and Public Policy and Sanjay Subhedar Fellow,
Kelley School of Business, Indiana University.
|
