One of the merits of the notion of sequential equilibrium is the emphasis on out-of- equilibrium beliefs-that is, on beliefs (about past and future play)at information sets that should not be reached if given equilibrium is played. The key insight of extensive-form analysis is that out-of-equilibrium beliefs deter. mine equilibrium behavior. For instance, consider the simple two-stage entry deter- rence game in which potential entrant decides whether to enter a market or stay out, and the incumbent decides whether to fight or acquiesce after the entrant's move
Signaling games are used to model the following situation: Player 1, the Sender, receives some private information and sends a message m E M to Player 2, the Receiver. The latter, in turn, observes m but not 0, and chooses response r E R. Players'payoffs depend on 0, m and r. What could be simpler? Yet, there is a huge number of economically interesting games that fit nicely within this framework: Spence's job market signaling model is the leading example, but applications abound in IO (limit pricing, disclosure...) finance (security design) and political economics
