Subgame Perfect Farsighted Stability∗

Farsighted game theoretic solution concepts have been shown to provide insightful results in many applications. However, we provide simple examples demonstrating that the existing solution concepts may fail to incorporate some important aspects of farsighted reasoning. This failure stems apparently from the reliance of these concepts on constructs such as indirect dominance which only provide limited foresight. Accordingly, we explore in this paper the implications of replacing indirect dominance with subgame perfection. That is, we propose a new farsighted solution concept, the Subgame Perfect Consistent Set (SPCS), based on consistency in the spirit of the von Neumann Morgenstern solution and on subgame perfect equilibrium. Surprisingly, the SPCS is shown to always lead to Pareto efficiency in farsighted normal form games. This result is demonstrated in various oligopolistic settings, and is shown to imply, for example, that players who follow the SPCS reasoning are always able to share the monopolistic profit in farsighted settings based on Bertrand and Cournot competition, and are always able to achieve coordination and Pareto efficiency in decentralized supply chain contracting, even when they are unable to form coalitions.