Repeated Games with Observation Costs

This paper analyzes repeated games in which it is possible for players to observe the other players’ past actions without noise but it is costly. One’s observation decision itself is not observable to the other players, and this private nature of monitoring activity makes it difficult to give the players proper incentives to monitor each other. We provide a sufficient condition for a feasible payoff vector to be approximated by a sequential equilibrium when the observation costs are sufficiently small. We then show that this result generates an approximate Folk Theorem for a wide class of repeated games with observation costs. The Folk Theorem holds for a variant of prisoners’ dilemma, partnership games, and any games in which the players have an ability to “burn” small amounts of their own payoffs. Journal of Economic Literature Classification Numbers: C72, C73, D43, D82.