The return of commitment

So far I have argued that for a commitment technology to be useful, the committed player must be able to tell the other player that he is committed. In particular, it is important that the message the committed player sends cannot be replicated by a non-committed player who is simply bluffing. Section 3 showed that this result is reasonably robust to the relaxation of the perfect disguise assumption. However in this Section I show that if we combine imperfect disguise with either an observation technology or an outside option, this can reverse the result and leave us with the

commitment outcome.

With observation

Now I assume that Bhas a third strategy, this being to pay amount k >0 to observe

whether Ais actually committed. As an example of how this might work in practice,

consider the case of the firm and union again, which was mentioned at the end of Section 2. Suppose the firm is able to make contact with an individual in the union camp who would be prepared to act as a spy and they could bribe to inform the firm about the union’s position. Would this be beneficial for the firm? In the short term the answer may be yes. However in the long run, the answer is no. If the union becomes aware that the firm is using this tactic, it can exploit this by committing itself to higher demands, knowing that the firm will observe the commitment. Even if the union is unaware such a tactic is being used, union negotiators may notice that those who commit themselves to high demands do better than those who do not, and so start using this tactic. Thus in the long run, we would expect the commitment outcome (c,1−c) to prevail. The model below will confirm this logic.

I introduce the following slight variation to the game previously discussed in Figure

3. Now B has the option to use an observation technology at cost k (the sum of the

bribe in the example above), which enablesB to discover whether or notA is indeed

committed to demanding c. If B chooses not to use the observation technology, he

faces the same dilemma as in Figure 2.3.1 on page 85. The new game, with this observation techonolgy is given in Figure 2.4.1 on page 89.

The game can thus be described as follows: after the decision of A whether or

not to commit, B decides whether or not to use the observation technology with cost

k. If B uses this observation technology then players play the backwward induction

equilibrium from this point. As well as making sense from a payoff perspective, this is also the only sensible outcome given the meaning of the strategies in the

A C B Nature B S H S H (0,0) (𝑐, 1 − 𝑐) (𝑐, 1 − 𝑐) (𝑤, 1 − 𝑤) λ 1 −λ (𝑤, 1 − 𝑤) S H O C B (𝑐, 1 − 𝑐) (0,0) (𝑤, 1 − 𝑤) (𝑟, 1 − 𝑟) B A Not observe Not observe Observe Observe (𝑤, 1 − 𝑤) (𝑐, 1 − 𝑐) (𝑐, 1 − 𝑐 − 𝑘) (𝑤, 1 − 𝑤 − 𝑘) In normal form In extensive form B observes commitment and hence chooses to give in. B observes a bluff and so holds firm, forcing A to back down.

Figure 2.4.1: Imperfect disguise and observation technology

game. The fact that B pays k in order to observe whether or not A is committed

suggests that he plans to use this information optimally. On the other hand, if B

does not use the observation technology, he faces the same game as in Figure 2.3.1 on page 85. Although this generates an extensive form game, I justify the normal form representation by arguing that ifBchooses not to observe he knows he is heading into the game of Figure 2.3.1 on page 85 and so should know what strategy he plans to use in this game, when deciding whether or not to deploy the observation technology. Therefore we can think ofBmaking a choice between his three sensible strategies all at once. These three sensible strategies being: to “not observe” and play Soft (denoted

S); “not observe” and play Hard (denoted H); to observe and respond optimally to

this observation (denoted O).

Here it was assumed thatBmust decide whether to use the observation technology

prior to discovering whether A was bluffing with probability λ through “Nature’s”

move. This allows the payoff matrix to be compatible with the other interpretation of the payoffs in the imperfect disguise game (the Normal form representation in

to renegotiate the agreement. The alternative assumption of allowing Nature’s move prior to the decision ofBwhether to use the observation technology would not change the analysis greatly9_.

In order for the observation technology to conceivably be useful, it must not be too expensive. Ifk > (1−_1+cc)(₊r_r−₋w_w) then it can never be a best response to use it: Letpcbe the

proportion of agents in populationA choosing C, then agents in population B would

always do better choosing either S or H, depending on whether pc is relatively high

or low. For this reason I henceforth assume 0< k < (1−₁₊c_c)(₊r_r−₋w_w) which means that for “small”pcthe best reply isH, for “medium”pcthe best reply will beOand for “large”

pc the best reply will be S.10 Given k > 0, the only pure strategy Nash Equilibria

are (C, S) and (B, H) and so x(C,S) _{= ((1,0),(1,0,0)) and x}(B,H) _{= ((0,1),(0,1,0))} are still the only two candidates for being stochastically stable11_.

As k decreases the size of the middle interval, where O is the best reply, increases at the expense of the other two. In particular this means that from the state x(B,H)

fewer population A mutations are required to make O the best reply. Once O is the

best reply, the proportion of population B playing O can then expand, followed by

the proportion of population A playing C expanding, followed by the proportion of

population B playingS expanding, all without the need for further mutations. Thus

the observation technology acts as a conduit to allow easier passage from x(B,H) _to x(C,S)_{. Ifk is small enough so that the number of mutations required to reach x}(C,S) from x(B,H) is less than the number of mutations to move in the opposite direction then x(C,S) replacesx(B,H) as the stochastically stable state.

9_{Strategy “O” would then mean to observe if unsure. The payoff matrix would be virtually}

identical to Table 3, the only difference being that the payoff to strategies (B, O) increases byλk to 1−w−(1−λ)k. The impact of this change on the analysis is negligible and it has no effect on ny of the conclusions.

10_{Small, medium and large are relative terms here. The parameters (c, r, w, k) determine the sizes}

of these 3 intervals and hence what is meant by small, medium and large

11_{It is also possible to have a mixed strategy Nash Equilibrium withBmixing betweenOandH,}

but due to populations being finite, generically there is no absorbing state corresponding to this, and even if there is, this we would be just one mutation from the Weak Basins of the other two absorbing states.

The path decsribed above took us to x(C,S) _fromx(B,H) _{via the following four step} process:

1. ₍₁₋k_c) proportion of population A mutate fromB to C. 2. Selection increases the proportion of O in populationB. 3. Selection increases the proportion of C in populationA. 4. Selection increases the proportion of S in populationB.

An alternative way to make this journey from x(B,H) tox(C,S) is for w_c proportion of

population B to mutate from H to O. This cuts out the first step of the above four

step process and replaces selection by mutation in the second step. Although, if we assume r is relatively close to c then _w(c₊−_cr₋)_r < w_c and so population B mutations are more likely to lead us from x(C,S) _{to x}(B,H) _{than vice-versa. Hence the more likely} way the observation technology is going to make a difference is via the four step

process described above. One may even think it to be the salient case to consider k

small relative to 1−c, making the four stp process described above quite likely. For instance, in the firm-union example, it is quite conceivable that it be a lot cheaper for a firm to bribe a union official than to suffer the consequences of disagreement. Theorem 31. Let NA_=NB _{=N → ∞ and r >} c−c2_+w2

1−c+w (so that x

(B,H) _{is the LRE}

without an observation technology).

If minn₍₁₋k_c),w_co<minn_w(c₊−_cr₋)_r,₁₋(1−_c+rc₋)_wo, then x(C,S)is the LRE. If minn k

(1−c),

w c

o

>minn_w(₊c−_cr₋)_r,₁₋(1−_c+rc₋)_wo, then x(B,H) is the LRE.

Proof. From x(B,H) _{to escape its Strong Basin, SBx}(B,H)_{, we need one of the fol-} lowing three things to happen: (i) l₍₁₋N k_c)m of population A mutate from B to C and we follow the four step process described above; (ii) lN w_c m of population A mutate

from B to C and followed by steps 3 and 4 of the process described above; (iii)

l _N(r−w)

1−c+r−w

m

for population B. Also, x(B,H) _{is the furthest state away from the Weak Basin of} x(C,S)_{, thus} CRx(C,S)=Rx(B,H)= min (& N k (1−c) ' , _{N w} c , & N(r−w) 1−c+r−w ')

The addition of the observation technology makes no difference to the shortest path fromx(C,S) _tox(B,H)_{. Thus it is still the case that}

CRx(B,H)=Rx(C,S)= min (& N(c−r) c−r+w ' , & N(1−c) 1−c+r−w ')

Note that it is not necessary to consider the l₁₋N(_cr₊−_rw₋)_wm because of the assump- tion that r > c−₁₋c2_c+₊w_w2. Then we can see that for N large enough minn₍₁₋k_c),w_co < minn_w(₊c−_cr₋)_r,₁₋(1−_c+rc₋)_wo implies that Rx(C,S) _{> CRx}(C,S) _{and thus using Elli-}

son’s Radius-Coradius Theorem x(C,S)_{is the LRE. Similarly for N large enough,}

minn₍₁₋k_c),w_co > minn_w(₊c−_cr₋)_r,₁₋(1−_c+rc₋)_wo implies Rx(B,H) _{> CRx}(B,H) _{and thus} the LRE is x(B,H).

This shows that the combination of a relaxation of the perfect disguise assumption and a cheap observation technology is enough to cause the commitment outcomex(C,S) to prevail. At first it may seem surprising that the addition of an observation option which doesn’t get used in the long run should harm B like this. The intuition is the

following: when population A is split between committing and bluffing, using the

observation technology is a good idea and increases the instantaneous payoff for the

player using it. However, the fact that O increases in popularity will increase the

fitness of C for population A agents and so this proportion rises. So while playing

O may be good at the time for the individual population B agent, the fact that he

and others act in this way has negative long term consequences for the agents in

population B as a whole.

Example 32. Appending Table 2.3.2 on page 87 with an observation column, where k = 0.01 gives the following payoffs:

S H O

C (0.8,0.2) (0,0) (0.8,0.19)

B (0.75,0.25) (0.5,0.5) (0.5,0.49)

Just as in the previous Table 2.3.2 on page 87, where it was found that x(B,H) _is the LRE, it takes either4_{/9 of populationA or}1_{/11of populationBmutating to travel} fromx(C,S)tox(B,H). However, now the introduction of the observation option makes it much quicker to travel from the x(B,H) _{to x}(C,S)_{. If1/20 of population A mutating}

from B to C then O becomes a best response for agents in population B. So the

proportion of populationB playing O expands without any further mutations. Once

this proportion reaches3_{/8,Cbecomes a best response for agents in population Aand}

so without any further mutations, the proportion playing C expands until it reaches

one. This in turn makes S a best response instead of O for population B agents and

so we end up with all of population B playingS and so we reach thex(C,S) state. So by going via states in which some agents to observe, we have found a way to travel fromx(B,H) _tox(C,S) _{which only requires}1_{/20of population A to mutate. Thus when} the two populations are similar sizes and large enough so that lN1

20 m <lN2 11 m , we find that x(C,S) _{is the LRE.}

With outside options

Now we return to the imperfect disguise game of Figure 2.3.1 on page 85 and instead of giving B an observation technology, give A an outside option (action T) which he can decide to take instead of heading into the bargaining game. This is represented in Figure 2.4.2 on page 94.

WhenA takes the outside option, we may think it natural to setB’s payofft2 = 0, if for example, the outside option is doing a deal with an outside party. However the

A C B Nature B S H S H (0,0) (𝑐, 1 − 𝑐) (𝑐, 1 − 𝑐) (𝑤, 1 − 𝑤) λ 1 −λ (𝑤, 1 − 𝑤) S H C B T (𝑡1, 𝑡2) (𝑐, 1 − 𝑐) (0,0) (𝑤, 1 − 𝑤) (𝑟, 1 − 𝑟) B A T (𝑡₁, 𝑡₂) (𝑡1, 𝑡2) (𝑤 < 𝑡1< 𝑐) In extensive form A takes the outside option

Figure 2.4.2: Imperfect disguise with outside option results will not depend on t2.

As an example, consider the house buyer scenario and suppose A has the option

of purchasing a different house for a set price. In this instance it is important that the house buyer must make a choice between which of the two houses to pursue, which is true if for example the decision on whether to buy this other house has to be made before he will hear back fromB, the seller. If the converse was true,A could commit in his dealings with B, and if B does not give in, use the outside option as a backup. In the firm-union example, the outside option might be for the union to bring in an independent adjudicator who will decide on what a “fair” rate of pay would be. In this instance, a deal is struck between the two parties and so t2 >0.

I assume that t1 ∈(w, c) so that the problem is not trivial. If the outside option was any less attractive, it would make no difference, as it would not be used; any more attractive and it would always be used. Now the Nash Equilibrium set changes: (C, S) is still a Nash Equilibrium and there is a connected componenet of Nash Equilibria where A plays T and B plays S with probability of no more than ¯p= minn_rt−₋w_w,t_co. Once again, the absorbing states of the population game correspond to these Nash

Equilibria, however onlyx(C,S) _{is stochastically stable.}

Theorem 33. For sufficiently large population sizes x(C,S) _{= ((1,0,0),(1,0)) is the}

LRE.

Proof. (C, S) is a strict Nash Equilibrium, so for sufficiently large population sizes, it is clear that it requires more than two mutations to exit the Strong Basin of Attraction ofx(C,S)_{. HenceRx}(C,S)_{>2. I now argue thatCRx}(C,S)_{≤2 (in fact, generically} is just 1) and hence the result follows from the Radius-Coradius Theorem.

If we are at a state in which the current best reply for population A is C then

no mutations are needed to reach x(C,S)_{, since the proportion playingC increases by} selection, and once this is high enough, the proportion ofS in population Bincreases

by selection. If the current best reply in population A is T then the proportion

playing T expands until all of population A are playing it. From here, suppose that

one member of populationAmutates toC. Then the agents in populationB will find

S the best reply and so the proportion playingSexpands via selection until it reaches the entire population, from which point C also becomes a best reply for populationA and we reach x(C,S) without any further mutations. If we are at a state where agents

in population A find B is the best reply then the proportion playing B increases,

thus making H the best reply for population B. Once the proportion of population

B playingH is large enough,T then becomes the best reply for populationAand we

are in the same case as before.

So if there is a unique best reply in population A then it only takes one mutation to reach x(C,S). If12 we happen to be in a state where there are two best replies for populationA, then we introduce a mutation in populationBso that there is a unique Best Reply and use the result above. This shows that CRx(C,S)_≤2.

This result holds for any t ∈ (w, c). The intuition is a forward induction type

12_{This is very unlikely. Indeed given the finite population assumption requires a specific mix of}

argument: The decsion of A to turn down the outside option means that he expects to do better in the imperfect disguise game than he would by taking the outside option. This means that (C, S) instead of (B, H) should be expected to prevail in this game. It is well known, for example [35] that stochastic stability has forward inducton properties.