This document provides an introduction to game theory. It discusses that game theory is a method for analyzing strategic interactions between players where an individual's outcome depends on the choices of others. Some key concepts discussed include Nash equilibrium, where no player benefits by changing only their own strategy; prisoners' dilemma, where cooperation is difficult; and different types of games such as cooperative/non-cooperative games and normal form/extensive form games. Examples like the dictator game and volunteer's dilemma are also summarized.
This document provides an introduction to game theory. It discusses that game theory is a method for analyzing strategic interactions between players where an individual's outcome depends on the choices of others. Some key concepts discussed include Nash equilibrium, where no player benefits by changing only their own strategy; prisoners' dilemma, where cooperation is difficult; and different types of games such as cooperative/non-cooperative games and normal form/extensive form games. Examples like the dictator game and volunteer's dilemma are also summarized.
This document provides an introduction to game theory. It discusses that game theory is a method for analyzing strategic interactions between players where an individual's outcome depends on the choices of others. Some key concepts discussed include Nash equilibrium, where no player benefits by changing only their own strategy; prisoners' dilemma, where cooperation is difficult; and different types of games such as cooperative/non-cooperative games and normal form/extensive form games. Examples like the dictator game and volunteer's dilemma are also summarized.
This document provides an introduction to game theory. It discusses that game theory is a method for analyzing strategic interactions between players where an individual's outcome depends on the choices of others. Some key concepts discussed include Nash equilibrium, where no player benefits by changing only their own strategy; prisoners' dilemma, where cooperation is difficult; and different types of games such as cooperative/non-cooperative games and normal form/extensive form games. Examples like the dictator game and volunteer's dilemma are also summarized.
Biplab Sarkar Department of Management Studies MANAGERIAL ECONOMICS
Game Theory Introduction
Biplab Sarkar Department of Management Studies MANAGERIAL ECONOMICS Game Theory Introduction
Game theory is a method of analysing strategic interaction. • It is concerned with “how individuals make decisions when they are aware that their actions affect each other and when each individual takes this into account”
• Game theory is a mathematical tool that helps to study strategic situations in which players optimize a variable not only on the basis of their own preferences, but also on other player’s decisions and reactions.
Game theory is largely attributed to the work of mathematician John von Neumann and economist Oskar Morgenstern in the 1940s and was developed extensively by many other researchers and scholars in the 1950s. It remains an area of active research and applied science to this day.
Different types of moves taken by different players in various games are systematically and structurally used explain economic theory specifically to understand firm’s behaviour.
1950, John Nash demonstrated the idea of an equilibrium situation in which all players in a game chose strategies or actions which are best for them, given the opponent’s choice. MANAGERIAL ECONOMICS Game Theory Introduction
Game theory and the economics of cooperation
• Game theory is the study of how people behave in strategic situations.
• Strategic decisions are those in which each person, in deciding what actions to take, must consider how others might respond to that action. • As the number of firms in an oligopolistic market is small, each firm must act strategically. • Each firm knows that its profit depends not only on how much it produces but also on how much the other firms produce. MANAGERIAL ECONOMICS Game Theory Introduction
Assumptions
• Each decision maker has two or more well specified choices or sequences of choices • Every possible combination of plays available to the players leads to a well defined end state(win, loss or draw) to terminate the game • A specified payoff for each players associated with each end state(Zero sum, Constant Sum or Non zero sum) • Perfect knowledge of the game and Payoffs • Rational players/ decision makers MANAGERIAL ECONOMICS Game Theory Introduction
Let's start by defining a few terms commonly used in the study of game theory:
•Game: Any set of circumstances that has a result dependent on the actions of two or more decision- makers (players) •Players: A strategic decision-maker within the context of the game •Strategy: A complete plan of action a player will take given the set of circumstances that might arise within the game •Payoff: The payoff a player receives from arriving at a particular outcome (The payoff can be in any quantifiable form, from dollars to utility.) •Information set: The information available at a given point in the game (The term information set is most usually applied when the game has a sequential component.) •Equilibrium: The point in a game where both players have made their decisions and an outcome is reached MANAGERIAL ECONOMICS Game Theory Introduction
Strategies
1. Pure Strategies – when a strategy specifies one and the same particular action at each decision point in a game.
2. Dominant and Dominated Strategy –
• Optimum strategy taken by a player which maximizes its outcome, whatever is the strategy of its opponents • Suppose given all combination of strategies of the other players, the outcome derived by a player from strategy A is better than that of strategy B. • Strategy A is Dominant Strategy and B is Dominated Strategy. • A dominant strategy equilibrium is one in which all the players have a dominant strategy.
3. MaxMin Strategy – • Maximizes among the worst case payoffs of a player. • The Maxmin value of the game for a player is that minimum amount payoff guaranteed by a Maxmin strategy in which a player minimizes the best case payoff of its rival. • The Minmax value of 2 players for player 1 is maximum amount of payoff that other player could achieve under player’’1 Minmax strategy. MANAGERIAL ECONOMICS Game Theory Introduction
4. Nash Equilibrium
It proposes a strategy for each player such that no player has the incentive to change its action unilaterally, given that the other player follow the proposed action. It is the optimal collective strategy in a game involving two or more players, where no players has anything to gain by changing his/her strategy.
The new assumption –
Firm 1 uses an expensive advertising agency and would shift the burden of increased cost to the consumer by increasing the price of the product, so that company gets a lesser market share when it advertises, as compared to when it does not advertise. If Firm 2 does not advertise, then it is better for Firm 1 not to advertise and get larger share of the market. Firm 1 and Firm 2 do not have dominant strategies. What would happen to the equilibrium outcome in this case?
Two Nash equilibrium
1. It occurs when both companies advertise 2. 2. When both do not advertise Each firm is better off if it plays the same strategy as the other firm and both Nash equilibrium occur when both the firms simultaneously play the same strategy. Any Maxmin strategy profile confers to Nash equilibrium. A Minmax strategy by both players also leads to Nash equilibrium. MANAGERIAL ECONOMICS Game Theory Introduction Types of Game
1. Cooperative and Non Cooperative Game
•Cooperative game are essentially those which entails cooperation among players. In real business world such cooperation is considered to be illegal. •Non cooperative games are where there is no possibility of tie up among players like in case of cut throat competition.
2. Normal form and Extensive form Games
•Normal form game lists each player’s strategies and possible outcome they derive from each strategy of the opponent. An outcome is revealed by the payoff matrix and each player’s payoff is denoted by a number to measure the utility derives from each strategy. •Extensive form of Game or Game tree gives complete plan of action of the players over a period of time. •It gives chronological order in which players take their action at that particular point of time , dependent on what they know at that point.
3. Two person Games and n person Games
•Classification is on the basis of number of players MANAGERIAL ECONOMICS Game Theory Introduction
4. The Prisoners’ Dilemma
• The prisoners’ dilemma provides insight into the difficulty in maintaining cooperation. • Often people (firms) fail to cooperate with one another even when cooperation would make them better off. • The prisoners’ dilemma is a particular “game” between two captured prisoners that illustrates why cooperation is difficult to maintain even when it is mutually beneficial. • Two suspects are arrested for armed robbery. They are immediately separated. If convicted, they will get a term of 10 years in prison. However, the evidence is not sufficient to convict them of more than the crime of possessing stolen goods, which carries a sentence of only 1 year. • The suspects are told the following: If you confess and your accomplice does not, you will go free. If you do not confess and your accomplice does, you will get 10 years in prison. If you both confess, you will both get 5 years in prison.
The dominant strategy is the best strategy for a player to follow regardless of the strategies chosen by the other players. • Cooperation is difficult to maintain, because cooperation is not in the best interest of the individual player MANAGERIAL ECONOMICS Game Theory Introduction
5. Dictator Game
This is a simple game in which Player A must decide how to split a cash prize with Player B, who has no input into Player A’s decision. While this is not a game theory strategy per se, it does provide some interesting insights into people’s behavior. Experiments reveal about 50% keep all the money to themselves, 5% split it equally, and the other 45% give the other participant a smaller share.
The dictator game is closely related to the ultimatum game, in which Player A is given a set amount of money, part of which has to be given to Player B, who can accept or reject the amount given. The catch is if the second player rejects the amount offered, both A and B get nothing. The dictator and ultimatum games hold important lessons for issues such as charitable giving and philanthropy. MANAGERIAL ECONOMICS Game Theory Introduction
6. Volunteer’s Dilemma
In a volunteer’s dilemma, someone has to undertake a chore or job for the common good. The worst possible outcome is realized if nobody volunteers. For example, consider a company in which accounting fraud is rampant, though top management is unaware of it. Some junior employees in the accounting department are aware of the fraud but hesitate to tell top management because it would result in the employees involved in the fraud being fired and most likely prosecuted.
Being labeled as a whistleblower may also have some repercussions down the line. But if nobody volunteers, the large-scale fraud may result in the company’s eventual bankruptcy and the loss of everyone’s jobs. MANAGERIAL ECONOMICS Game Theory Introduction
7. The Centipede Game
The centipede game is an extensive-form game in game theory in which two players alternately get a chance to take the larger share of a slowly increasing money stash. It is arranged so that if a player passes the stash to their opponent who then takes the stash, the player receives a smaller amount than if they had taken the pot.
The centipede game concludes as soon as a player takes the stash, with that player getting the larger portion and the other player getting the smaller portion. The game has a pre-defined total number of rounds, which are known to each player in advance. MANAGERIAL ECONOMICS Game Theory Introduction
Limitations of Game Theory
The biggest issue with game theory is that, like most other economic models, it relies on the assumption that people are rational actors that are self-interested and utility-maximizing. Of course, we are social beings who do cooperate and do care about the welfare of others, often at our own expense. Game theory cannot account for the fact that in some situations we may fall into a Nash equilibrium, and other times not, depending on the social context and who the players are. THANK YOU
Biplab Sarkar Department of Management Studies biplabsarkar@pes.edu +91 80 6666 3333 Extn 337
