GAME THEORY
INTRODUCTION TO GAME THEORY
Understanding the Game
Game theory: The study of decision-making in situations
where one player’s outcome depends on the decisions of
other players.
A strategic game is the fundamental schema for analyzing
decision-making via game theory. They have three elements:
1. Players: Participants in the game. Remember: Games can
2. Actions: A player’s options for how to behave in the be played sequentially or
game. Taken together, the players’ actions create an simultaneously, but the latter
outcome. lend themselves to more
3. Payoffs: The results associated with a given outcome. straightforward analysis.
In simultaneous games, players select their actions at the
same time.
The Normal Form and Nash Equilibria
The normal form (strategic form) is a concise method for
representing a strategic game.
Best responses (or strategies): The actions that maximize a
player’s payoff given the actions of the other player. Matrices: Some Examples
Strategic form is typically drawn as a matrix, with players’ Regina
best responses marked with stars. lower price keep price
keep price lower price
A formal prediction is called a solution concept, but one only $5,000 $10,000
exists when all players have at least one best response in $5,000 $2,500
Ralph
common.
Nash equilibrium: A set of actions wherein each player’s $2,500 $7,500
action is a best response given the actions of all other $10,000 $7,500
players.
A game may contain one Nash equilibrium (e.g., the matrix Regina
lower price keep price
with the yellow highlight), or more than one, or none at all.
keep price lower price
Nash equilibria can solve non-cooperative games, i.e., ones $5,000 $10,000
$5,000 $2,500
lacking a formal method for ensuring player cooperation.
Ralph
The prisoner’s dilemma is an example of a non-
$2,500 $7,500
cooperative game. $10,000 $7,500
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GAME THEORY
Dominance and Rationalization
Strictly dominant: A strategy that always provides higher A game in which the strategies
payoffs than the other(s). of both players are intransitive.
Weakly dominant: A strategy that provides higher payoffs in Tom rock paper scissors
at least one outcome, and equal payoffs in all others. Alexa
rock 0,0 –1,1 1,–1
Intransitive: No strategy dominates.
Rationalization: A solution concept involving the evaluation
paper 1,–1 0,0 –1,1
of a game’s strategies from each player’s perspective. The
iterated elimination of strictly dominated strategies is an
example: scissors –1,1 1,–1 0,0
1. Examine the game from Player 1’s perspective. Remove
any of their strictly dominated strategies.
2. Do the same from Player 2’s perspective. Repeat until
no strictly dominated strategies remain for either player.
3. Any outcomes that survive this process are
rationalizable strategies. If only one survives, the game
is dominance solvable.
Extensive-Form Games
The extensive form is a means for modeling sequential
Examples of exenstive form:
games. Its major components are:
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• Game tree: A decision tree used to show players, sp ape $20,000
Regina SG2 New
strategies, and payoffs.
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• Node: Each circle on the game tree represents a TV io $35,000
$25,000
decision point for the respective player.
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• Branch: Shows the possible strategies at each node. Bil
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• Terminal node: Shows the payoffs tied to each chain of
SG1 Rad $40,000
decisions. io
$25,000
Backward induction: A method for solving extensive-form
Ralph $35,000
games. $25,000
Regina
TV Rad $35,000
io
$25,000
$25,000
Bil er
lbo spap $35,000
ard New
$25,000
$35,000
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GAME THEORY
After breaking the game down into smaller subgames:
1. Identify Player 2’s best responses based on her
payoffs at the terminal nodes. Eliminate the remaining
strategies.
2. Shift those payoffs forward, creating new terminal
nodes. Then select Player 1’s best response.
3. The surviving chain of strategies is called a subgame
perfect equilibrium.
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