Chapter 5: Correlated Equilibrium
While Nash equilibrium is the central concept in non-cooperative game theory, and has many applications, it is not quite the whole story. There are rival solution concepts and applications that are prescriptive rather than diagnostic. This chapter will discuss a major alternative: correlated strategy equilibrium. A few years ago in New Zealand (Bray, 2003), telecommunications companies Teamtalk Ltd and MCS Digital Ltd were embroiled in a lawsuit. If both were to pursue their claims in a court of law, the legal fees would be great enough that both would be worse off. If one knew for certain that the other would pursue his claim, then the best response would be to abandon the claim, to avoid the legal costs. However, neither was certain that the other would withdraw, nor was willing to be the one to withdraw unilaterally. They agreed to settle the difference by arm-wrestling, the winner to take the asset and the loser to abandon his claim. On the face of it, this may seem an irrational procedure, but on more careful consideration it is quite rational. The two businessmen had arrived at a correlated equilibrium solution to their problem. 5.1 INTRODUCTORY EXAMPLE AND DEFINITION Eastonia and Westoria are neighboring townships that share a business district on their border. Each is considering building a parking garage to serve the business district, but only one garage is economically feasible, so that if both build, both will be worse off. If one town builds, then the other has the further...
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