GAME THEORY
No Man is an Island, Human
Behavior is interdependent
GAME THEORY
Developed by John von Neumann and Oskar Morgenstern
Game theory is the study of how people interact and
make decisions
An analytical tool that allows decision makers to deal with
interdependence and uncertainty
Provides a framework for developing, testing and even
explaining intuition about strategic interactions
A multi-agent decision problem, where there are many
people contending for limited rewards/payoffs .
What is Game Theory?
Study of rational behavior in interactive
or interdependent situations
Good news: Framework for thinking about
strategic interaction
Bad news: Knowing game theory does
not guarantee winning
Irrational behavior : not dealt with YET !
WHAT IS A GAME?
A game has the following
Set of Players
Set of rules
Set of Strategies
Pay off
Players have to make certain moves on which their payoff
depends
Players have to follow certain rules while making these
moves
Each player is supposed to behave rationally
Rationality: Each player tries to maximize his/her payoff
Strategy: A course of action taken by one of the
participants in a game
Payoff: The result or outcome of the strategy
Payoff Matrix: Shows the outcomes or payoffs that result
from each combination of strategies adopted by the
players
The outcome depends on the strategies chosen by all
players; there is strategic interaction
Types OF GAMES
Co- operative Games Oligopoly etc.
Non Co- operative Games Prisoners
dilemma etc. .
Zero- Sum games Vs Non Zero- Sum
games My loss = Your Gain, and vice
versa The strategic payoff is easily
identified in the zero sum game.
In a non-zero sum game, there would be
existence of many Nash equilibrium
•Dominant
Strategies
•Dominated
Strategies
•Maximin
Strategies
•Mixed
Strategies
Dominant Strategies
Firm B
Advertise Don’t
Advertise
Advertise10,5 15,0
Firm A
6,8 8,2
Don’t Advertise
NASH EQUILIBRIUM
A Nash Equilibrium is defined as a set of strategies such
that none of the participants in the game can improve their
payoff, given the strategies of the other players
Firm 2
No price change Price increase
Firm 1 No
price 10,10 100,-
change 30
-20,30 140, 25
Price
increase
The Product Choice
Problem
Firm 2
Crispy
Sweet
-5,-5 10,10
Crispy
Firm 1 10,10 -5,-5
Sweet
The Beach Location Game
X and Y plan to sell soft drinks on a beach
in Goa in summer
The beach is 200 m long and sunbathers
are spread evenly across its length.
Both sell at the same prices ,so
customers will walk to the closest
vendor .
Where on the beach will X and Y
locate???
The Beach Location Game
Both will locate at the center of the beach
which is the only Nash Equilibrium
Maxi-min Strategies
Firm 2
Don’t Invest
Invest
0,0 -10,10
Don’t Invest
Firm 1 -100,0 20,10
Invest
Mixed Strategies
Pure
A strategy that defines a specific move or
action that a player will follow in every
possible attainable situation in a game
Mixed
A strategy consisting of more than one
possible moves, used when it is desirable
to keep the opponent guessing
Matching Pennies
Firm 2
Low Price
High Price
1,-1 -1,1
Low Price
Firm 1 -1,1 1,-1
High Price
The Battle of the Sexes
Raman
Movie
Opera
2,1 0,0
Movie
Radhika
0,0 1,2
Opera
NON-CO-OPERATIVE GAMES
• Not possible to negotiate with other participants and
enter into
some form of binding agreement
Example: Firms in oligopolistic markets are legally
prohibited by competition laws from coordinating their
prices
• May result in outcomes that are undesirable for
participants and society
One example of this is the Prisoner’s Dilemma
PRISONER’S DILEMMA
• Prisoners' Dilemma is a two-person game, but many of the
applications of the idea are really many-person interactions.
•We have assumed that there is no communication between the
two prisoners. If they could communicate and commit themselves
to coordinated strategies, we would expect a quite different outcome.
•In the Prisoners' Dilemma, the two prisoners interact only once.
Repetition of the interactions might lead to quite different results.
•Practical example is the arms race between the US and the erstwhile
Soviet Union
Prisoners’ Dilemma
Pay-Off Matrix
Tachikovsk
y Conductor
Conductor Don’t Confess Confess
Maximum
Don’t confess 3,3 25, 1 25
Confess 1, 25 10, 10 10
Tchaikovsky
Maximum 25 10
•Not confessing is the best joint
strategy
•Suspects may be risk averse and
adopt the minimax strategy
i.e both will confess and get a 10 year
sentence each
PRISONER’S DILEMMA IN ADVERTISING
Firm 2
Low-level High-level Minimum
Advertising Advertising (Firm 1)
Low-level 30,30 10, 40 10
Advertising
Firm1
High-level 40,10 20,20
Advertising 20
Minimum (Firm 2) 10
20
•Both firms will opt for the Maximin strategy and chose
the high-level advertising option.
•Both end up with a profit of 20 each
•Best strategy : Low-level advertising
COOPERATIVE GAMES : Enforcing a
Cartel
Possible to negotiate and enforce agreements that bind
the participants in the game to a particular strategy
If allowed, would lead to a different outcome of the
Prisoner’s Dilemma
Example: Experience of the Pan Masala industry in the
1980s. Government’s advertising ban converted the non
cooperative advertising war into a cooperative game.
REPEATED GAMES : Dealing with Cheats
Firms may be able to escape the Prisoner’s Dilemma if the
action is a repeated game, that is, if it is played many times
Optimal strategy is a tit for tat strategy
Tit for Tat strategy
Each firm should mimic it’s rivals behaviour from the previous
period
Never initiates cheating, that could cause a breakdown in
cooperation
Never rewards cheating by allowing such behaviour to go
unpunished
Allows cooperation to be quickly restored
Can break down if the players know for sure how many times
the game will be repeated, i.e cheat the last time the game is
played
SEQUENTIAL GAMES : The advantage
of Being First
Unlike a simultaneous response game, a sequential
game allows a player to respond after the first player
has made a move
Advantage to the first player
Entry into a new market
Firm 2
No New Introduce
Product New
Product
No New 2,2 -5,10
Product
Firm 1 Introduce 10, -5 -7, -7
New
Product
