Strategic Games for Business
Week 1
Introduction to Game Theory
Semester 2, 2024
Active Learning
opportunity
Game theory
Plan:
• Introduction
• Equilibrium Analysis of Simultaneous Games
• Equilibrium Analysis of Sequential Games
• Mixed strategies
• Auctions & Games with incomplete information
Overview
In today’s lectorial we will cover a series of Micro Learning topics including:
• Games of Strategy + Examples
• Game theory
• Classifying Games of Strategy
• Terminology and Assumptions
Micro Learning topic
Games of Strategy
What are Games of Strategy?
Most games that we play require some element of chance, skill
and strategy.
Pure Chance Pure Skill Games of Strategy
Playing double Running 100m These are different
or nothing on a sprint or shooting
coin toss or at the Olympics Characterized by the
lotteries. presence of strategic
thinking
Minimum of 2 players
Each players uses tactics to
maximize chances of
winning.
Each player knows that their
opponent is also trying to
win.
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Let’s play
Examples of Games of Strategy
Game 1: Rock, Paper, Scissor
Description: Player A and Player B simultaneously decide
on one of the three options: Rock or Paper or Scissors.
What to choose? Rock,
Paper, Scissor?
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Game 2: Poker
Description: Poker is any number of card
games in which players wager over which hand
is best according to specific rules of the game.
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Game 3: The Rat Race at work
Description: Most workplaces give a raise or
promote employees based on their
performance relative to others in the
workplace. They have a set number of people
they want to promote or give a financial bonus.
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01. Work hard 03. Time goes by
Employees must
work hard in both As weeks go by, each
absolute and relative employee has the
terms temptation to renege
on the agreement
02. Let’s discuss 01 02 03 04 04. Effort
All employees realize
this is a poor situation Working hard when
and meet at a bar after others are not gets
work to agree to not you higher payoff
work hard the following Prisoner's dilemma
year.
The Rat race at work
This is a game of strategy because you have many players, and each player is trying to do best
for themselves (win).
Game 4: Gift exchange game
Should you be nice to your employees?
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Should you be nice to This is called a gift
your employees? exchange game
Employer payoff is
dependent on effort put
in by employees and is
based on employer
Employees have the generosity and the
option of putting in effort exerted.
minimum effort or
putting more than
minimum effort.
As an employer,
you can treat
your employees
fairly or go even
beyond fair and
be nice to them. 03 04
02
01 This is a game of strategy because it has
many players. Each player is trying to do best
for themselves
Game 5: Why are professors so reluctant to believe you?
Professors are generally not happy to give
extensions. Are they really mean? Or is it a
strategy?
Examples of Game Strategy
Professors are generally not happy to give assessment
extensions.
Are they really mean? Or is it a strategy?
• Most professors would like to give students extensions
for valid reasons
• However, its very hard to assess which excuses are
genuine.
• Providing benefit of doubts every time may be detrimental
and eventually lead to a situation, where deadlines
do
not mean anything.
• A good strategy would be to not grant anything anytime.
- hiding behind university regulations etc.
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Micro Learning topic
Game theory
Definition
Game theory is a structured approach to analyze strategic interactions.
An action situation is where there are two or more mutually aware players,
and the outcome for each depends on the actions of all.
General process
1 2 3 4
Model any In these games, Based on the Take insights from
strategic undertake analysis analysis, predict behavior in the
interaction in the by putting ourselves behavior of others game and
form of a game, into other players’ and potential extrapolate it to
with certain set shoes and outcomes in the the strategic
parameters. considering the game, explain interaction which
game from their behavior and advise was modelled.
perspective. strategies.
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Basic rules of a game
Players Decision makers 2 or more
(individuals, firms. Nations, etc)
Actions Decision alternatives each player has in Simultaneous or Sequential
their decision nodes. one shot or repeated
Outcome Combination of all players possible Zero-sum, constant sum.
actions with payoffs associated with each Some outcomes eventuate into
combination. equilibrium.
Information What each player knows about the game. Complete or incomplete.
Perfect or imperfect
Symmetric or
asymmetric
Communication Allowed or not. Cooperation allowed?
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A taxonomy of games
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Micro Learning topic
Sequential vs Simultaneous
Move Games
Moves are sequential
Player B
Gets to observe the
moves of Player A,
before choosing their
move.
Player A
White moves first
then black moves.
Player A (The Striker)
Players must decide simultaneously
Decides to go left/ right
Player B (The Goalie)
Must decide on his
move without knowing
Player A’s move
Sequential and Simultaneous elements
Many games include both sequential and
simultaneous elements.
In most team sports, teams enter the game
Tell us a
with a set strategy (simultaneous) which the sport
coach can change depending on
observations made during the game
(sequential).
Sequential vs Simultaneous Move Games
Normal Form Representation Extensive Form Representation
The strategic (or normal) form of a game consists of The sequential (or extensive) form consists of a
a payoff matrix (or table) which shows actions, game tree which shows actions, outcomes and
outcomes and payoffs. In this example, we show a payoffs.
2-player simultaneous game. In this example, we show a 2-player sequential
game.
Players play in sequence, i.e. P1 plays beforea,P2.
b
Column Player X
P2A
X Y
A
a, b c, d
Row Y c, d
e, f g, h P1
A Player X e, f
B B
P2B
Y g, h
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The distinction is important as different types of interactive thinking is
required for analyzing the two types of games.
Sequential Simultaneous
Each player must think if I do Each player needs to figure out
In political competition,
this, how will my opponent what their opponents are going
second movers have
react? Current moves are to do now, similarly the
advantage.
governed by future reactions. opponents are going to do the
same thing.
Sequential games may provide
advantage to first or second Current moves are not
movers. governed by future reactions.
In economic first movers
have advantage.
Player incentives
Player incentives
In many simple games, like chess or football, there are winners and
there are losers.
One player’s gain is another player’s loss.
These are called zero-sum games, where players interests are in
complete conflict.
Aligned or
Conflicting
Most economic and social games are not zero-sum.
incentives
Players interests may be aligned and this cooperation may be useful.
Eg Collaborating in research projects leads to better projects.
There can also be situations where there is a mix of conflict and
cooperation.
Increase the pie (cooperation) and splitting of the pie (conflict)
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Rules of the game
Fixed or Manipulable
When rules can be manipulated, the
• In most simple games, like chess and card real game is the “pre-game” where
games, rules are arbitrary but fixed. rules are set.
• In business, politics or ordinary lives,
players have some leeway with regards to The study of strategic moves tells us
setting rules of the games. how we can manipulate rules of the
game in the “pre-game” using
For example: commitments, promises and threats.
• Parents constantly try to make rules, The goal is to manipulate the rules of
which the children constantly try to the game to bring them to your favour
manipulate. in the subsequent games.
• In international negotiations, governments
always make threats or promises.
One shot vs Repeated Interactions
One shot game Repeated games
Interaction that happens only once. Occurs when a one shot game is
played repeatedly.
Analysis is simple
Actions must consider future interactions.
Actions are generally more ruthless. i.e more
in line with zero sum games. Worthwhile building a reputation
(tough, honest, fair)
Information about your opponent
usually limited.
Secrecy or surprise may be good strategies.
Games can be zero sum in the short run (one shot) and have scope of cooperation in
the long run (repeated).
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Let’s explore
• English Premier League Revenue
(football) sharing agreement.
• Clubs should behave selfishly. i.e.
winner takes all, but that would affect
competition in the long run and
reduce viewership.
Do players have full or equal
information?
In many games, all parties know the full history of the game. (eg chess)
In other games, players face limitations of information:
External uncertainty
Players might not know
information on internal and
external variables useful for
decision making in the
game.
Eg: Weather on the day of
a tennis game.
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Do players have full or equal
information?
In many games, all parties know the full history of the game. (eg chess)
In other games, players face limitations of information:
Strategic uncertainty
Players not aware of what prior moves or simultaneous moves
opponents can make.
Eg: You are not aware of that the possible choices your opponent
has.
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If a game has neither of these two types uncertainties, they
are called perfect information games, otherwise they are
called imperfect information games.
There are also games of incomplete/asymmetric information,
where one player has more information about aspects of the
game than the other players.
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Micro learning topic
Terminology and Assumptions
Terminology and Assumptions
Strategies
Strategies are the choices/decision alternatives available to players
at their decision node.
In simultaneous games, each player’s strategy is also the action
they undertake.
In sequential games, strategies are more elaborate.
Strategy: A complete plan of action for a player in a game, specifying the
action he would take at all nodes where it is his turn to act according to
the rules of the game (whether these nodes are on or off the equilibrium
path of play). If two or more nodes are grouped into one information set,
then the specified action must be the same at all these nodes.
Strategies X
a,
b
P2
In sequential games, strategies are more a
elaborate.
A
For every possible action undertaken by the Y
c,
opponent player, one must highlight what their
d
P1
X
response is. e,
f
B
For example, if your opponent has two possible
P2
actions (A and B) to choose from, then your b Y
strategy must include what to do if they choose A g,
h
and what to do if they choose B, regardless of
your beliefs about which action they are going to
choose.
Terminology and Assumptions
Pay-offs: are numbers associated with each
possible outcome of the game.
Let’s look at a Penalty kick as an example.
If the Kicker kicks left and Goalie dives right
(the shot is saved)
Payoff of Kicker is 0 and Goalie is +1
Generally, the higher the pay-off the better the
outcome.
Terminology and Assumptions
Rationality: This is the condition that all players in the
game are trying to maximize their own payoffs.
This implies:
1. Individuals know how to rank each outcome of the game
2. Can identify the strategy that allows her to achieve the
highest pay-off, i.e. optimize.
Note, that maximizing one’s pay-off does not make him/her
selfish. Regards for others’ well-being & image concerns are
already accounted for in payoffs.
Common Knowledge of the Rules
Rules of the game include:
1. The list of players
2. The strategies available to each player
3. The pay-offs for all possible combinations of strategies pursued by all
players.
4. The assumption that each player is rational
Common knowledge in this regard means:
1) All players know these rules of the game.
2) All players know that the other players also know these rules.
3) All players know that the other players know that all players know the
rules.
4) ……
Terminology and Assumptions
Equilibrium
When rational agents interact, the outcome achieved is the
equilibrium.
Each player is using the strategy that is the best response to
the strategies of the other players.
Alternatively, in equilibrium no player has the incentive to
deviate from the strategy they are playing given the strategies
available to the other player.
Terminology and Assumptions
Observation and Experiment
The reality of strategic interactions can be ascertained in (2) two ways.
1. By observing them as they occur naturally
2. By conducting special experiments that help us pin down the effects of
particular conditions.
Many predictions of theory are borne out, but many are not.
Leads to reinterpretations (often behavioral) of assumptions made.
Thank you
