Subgame perfect equilibrium

Definition

Subgame perfect equilibrium is a refinement of Nash equilibrium applicable in dynamic games, where players make decisions at various stages. It ensures that players' strategies are optimal not just in the overall game, but also in every subgame, which means that their actions must be credible and rational at every point of decision-making. This concept is crucial when analyzing sequential moves, as it strengthens the predictions of players' behavior by eliminating non-credible threats.

5 Must Know Facts For Your Next Test

1. Subgame perfect equilibrium is essential for games with multiple stages and helps to analyze the strategic interactions of players over time.
2. It is often used in extensive-form games, represented by game trees, where players make decisions at different points.
3. To find a subgame perfect equilibrium, one typically employs backward induction, ensuring that strategies remain optimal throughout all potential subgames.
4. A subgame perfect equilibrium can have multiple equilibria, but only those that are stable across all subgames are considered valid.
5. This concept rules out equilibria involving non-credible threats, which do not hold up if players were to reach that stage of the game.

Review Questions

• How does subgame perfect equilibrium enhance our understanding of strategy in dynamic games compared to Nash equilibrium?
  • Subgame perfect equilibrium enhances our understanding of dynamic games by ensuring that players' strategies are optimal not only overall but also in every possible subgame. While Nash equilibrium may allow for some non-credible threats, subgame perfect equilibrium eliminates these by requiring strategies to be credible at all stages of play. This leads to a more refined prediction of player behavior, particularly in situations where decisions are made sequentially over time.
• What role does backward induction play in determining subgame perfect equilibria, and why is it important?
  • Backward induction is crucial in determining subgame perfect equilibria as it allows players to reason backwards from the end of the game to identify optimal strategies at each decision point. By analyzing what the best response would be at later stages of the game, players can make informed decisions that will also be optimal when viewed from earlier stages. This method ensures that all strategies align with the requirement of being optimal throughout every subgame.
• Evaluate how subgame perfect equilibrium can apply in real-world scenarios, such as negotiations or business strategies.
  • In real-world scenarios like negotiations or business strategies, subgame perfect equilibrium provides a framework for predicting how parties will act when decisions unfold over time. For instance, in a negotiation, each party considers how their actions will affect future offers and responses. By using subgame perfect equilibrium, parties can identify credible commitments and threats that will guide their behavior throughout the negotiation process, ensuring that their strategies remain consistent and rational across various stages.

Related terms

Nash Equilibrium: A situation in a game where no player can benefit by changing their strategy while the other players keep theirs unchanged.

Backward Induction: A method used to solve dynamic games by analyzing the game's end and determining the optimal strategies backward to the initial decision point.

Perfect Information: A situation in a game where all players know the strategies and payoffs of all other players at all times.