Abstract. Experimentalists frequently claim that human subjects in the laboratory violate game-theoretic predictions. It is here argued that this claim is usually premature. The paper elaborates on this theme by way of raising some conceptual and methodological issues in connection with the very definition of a game and of players ’ preferences, in particular with respect to potential context dependence, interpersonal preference dependence, backward induction and incomplete information.

The concept of ‘fully permissible sets’ is defined by an algorithm that eliminates strategy subsets. It is characterized as choice sets when there is common certain belief of the event that each player prefer one strategy to another if and only if the former weakly dominates the latter on the set of all opponent strategies or on the union of the choice sets that are deemed possible for the opponent. The concept refines the Dekel–Fudenberg procedure and captures aspects of forward induction.

We justify the application to extensive games of a model of deductive reasoning based on three key features: ‘caution’, ‘full belief of opponent rationality’, and ‘no extraneous restrictions on beliefs’. We apply the model to several examples, and show that it yields novel economic insights. The approach supports forward induction, without necessarily promoting backward induction. In many economic contexts decision makers interact and take actions that extend through time. A bargaining party makes an offer, which is observed by the adversary, and accepted, rejected or followed by a counter-offer. Firms competing in markets choose prices, levels of advertisement, or investments with the intent of thereby influencing the future behaviour of competitors. One could add many examples. The standard economic model for analysing such situations is that of an extensive game. This paper is concerned with the following question: what happens in an extensive game if players reason deductively by trying to figure out one another’s moves? We have in Asheim and Dufwenberg (2002) (AD) proposed a model for deductive reasoning leading to the concept of ‘fully permissible sets’, which can be applied to many strategic situations. In this paper we argue that the model is appropriate for analysing extensive games and we apply it to several such games. 1.

Most literature on the hold–up problem starts from the assumption that ex post bargaining outcomes are insensitive to prior investment costs. We argue that this approach is unsatisfactory. If the bargaining procedure is relatively symmetric, it typically admits multiple perfect equilibria, some of which give the investor a high enough payoff to sustain efficient investment. Even if the bargaining procedure is asymmetric and rigged against the investor, there may be investment if agents are driven by moral concerns or if communication creates commitment. Laboratory experiments indicate that communication is necessary and sufficient for agents to coordinate on efficient outcomes when the bargaining game is symmetric. When the bargaining game is rigged against the investor, the hold–up problem is mitigated, but not eliminated, by moral behavior. Communication is quite credible, and we find that promises are more believable than threats. JEL classification: L14, C78.

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