<p>In your example, you would still use backward induction to solve for the Perfect Bayesian Equilibrium (assuming the distribution of private costs has full support). In fact, the second stage of your example is similar to a Bertrand competition with asymmetric information. You can refer to the following paper for a general solution of the second stage game: </p>

<ul>
<li>Spulber (1995) "Bertrand Competition When Rivals' Costs Are Unknown", <em>Journal of Industrial Economics</em> 43:1-11. </li>
</ul>

<p>The first stage decisions should follow in a straightforward manner. </p>

CC BY-SA 4.0
2019-07-31T17:07:22.480Z
2019-07-31T17:07:22.480Z
Herr K.
<p>I would like to solve a game where firms have private information about their own type, but only know the distribution of the other firm's type. They interact in two stages, where the strategies depend on each other. The first period is an optimization problem, and in the second period Nash Equilibria have to be identified.</p>
<h3>Example:</h3>
<p>Consider two firms, <span class="math-container">$A,B$</span> who are trying to sell their product to one customer.</p>
<p>The customer just needs one indivisible unit of the product, which has value V for the customer, and will buy the product from the firm that offers the lowest price.</p>
<p>Both firms initially are able to produce the product at cost <span class="math-container">$C$</span>, but each firm <span class="math-container">$i \in \{A,B\}$</span> may decrease it productions costs by <span class="math-container">$c_i$</span> in private by investing <span class="math-container">$d_i (c_i)^2$</span>.</p>
<p>Each firm <span class="math-container">$i$</span> has private knowledge about its own <span class="math-container">$d_i$</span>, but only knows the distribution of <span class="math-container">$d_j$</span>. (If the solution needs a specific distribution just pick one which fits your needs.)</p>
<p>The sequence of game stages is:</p>
<ol>
<li>The two firms simultaneously privately invest into cost reductions <span class="math-container">$c_A,c_B$</span>.</li>
<li>The firms set prices <span class="math-container">$p_A,p_B$</span> for the product.</li>
</ol>
<p>Straightforward backward induction does not work in my trials, due to the asymmetry of cost reduction investments.</p>
<p><strong>Question:</strong> Is there a good textbook or paper where sth. similar is done or do you have any technical knack which I have missed?</p>

<game-theory><nash-equilibrium><bayesian-game><oligopoly>
Perfect Bayesian Equilibrium in a two stage game with incomplete information
unicoerner
# Perfect Bayesian Equilibrium in a two stage game with incomplete information

(Asked by: username_0 on 2019-07-31)

I would like to solve a game where firms have private information about their own type, but only know the distribution of the other firm's type. They interact in two stages, where the strategies depend on each other. The first period is an optimization problem, and in the second period Nash Equilibria have to be identified.

### Example:

Consider two firms, $A,B$ who are trying to sell their product to one customer.

The customer just needs one indivisible unit of the product, which has value V for the customer, and will buy the product from the firm that offers the lowest price.

Both firms initially are able to produce the product at cost $C$, but each firm $i \in \{A,B\}$ may decrease it productions costs by $c\_i$ in private by investing $d\_i (c\_i)^2$.

Each firm $i$ has private knowledge about its own $d\_i$, but only knows the distribution of $d\_j$. (If the solution needs a specific distribution just pick one which fits your needs.)

The sequence of game stages is:

1. The two firms simultaneously privately invest into cost reductions $c\_A,c\_B$.
2. The firms set prices $p\_A,p\_B$ for the product.

Straightforward backward induction does not work in my trials, due to the asymmetry of cost reduction investments.

**Question:** Is there a good textbook or paper where sth. similar is done or do you have any technical knack which I have missed?

**Tags:** game-theory, nash-equilibrium, bayesian-game, oligopoly

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## 1 answers

### Answer by username_1 on 2019-07-31. Score: 3

In your example, you would still use backward induction to solve for the Perfect Bayesian Equilibrium (assuming the distribution of private costs has full support). In fact, the second stage of your example is similar to a Bertrand competition with asymmetric information. You can refer to the following paper for a general solution of the second stage game:

* Spulber (1995) "Bertrand Competition When Rivals' Costs Are Unknown", *Journal of Industrial Economics* 43:1-11.

The first stage decisions should follow in a straightforward manner.


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