Game Theory
Introduction
• Competition can be an important decision-
making factor.
• The strategies taken by other
organizations or individuals can
dramatically affect the outcome of our
decisions.
• Game theory is one way to consider the
impact of the strategies of others on our
strategies and outcomes.
Game Theory
• Game theory is one way to consider the
impact of the strategies of others on our
strategies and outcomes.
• A game is a contest involving two or more
decision makers, each of whom wants to
win.
• Game theory is the study of how optimal
strategies are formulated in conflict.
Game Theory
• Games are a convenient way to model
strategic interactions among economic
agents
• Many economic issues related to strategic
interaction:
– Pricing, advertising, investment decisions,
R&D, timing of actions, negotiating
• Not limited to economics
Assumptions made in game theory
• Payoffs are known and fixed
• Players behave rationally i.e. seek to maximise payoffs
(subject to the “rules” of the game)
• The rules of the games are common knowledge
– Each player knows the set of players, strategies
available and payoffs from all possible combinations
of strategies; call this information X
– Each player knows that all players know X
• Players attempt to maximise their payoffs by choosing a
strategy that is a “best” response
– Note: players will not necessarily be achieving the
maximum payoff
Zero-sum games
For simplicity, X and Y represent the two
game players. Zero sum means that the
sum of losses for one player must equal
the sum of gains for the other player.
When you sum the gains and losses for
both players, the result is zero.
1.The Minimax Criterion
• A player using the Minimax criterion will select
the strategy that minimizes the maximum
possible loss.
• Ex: zero-sum game
Y1 (use radio) Y2 (use newspaper)
X1 (use radio) 3 5
X2 (use newspaper) 1 -2
• A positive number means that X wins and Y loses. A negative
number means that Y wins and X loses.
• The game favours competitor X since all values are positive except
one.
• Since Y must play the game, he/she will play to minimize total
losses.
Minimax Solution
• zero-sum game
Y1 Y2
Minimum (X)
(use radio) (use newspaper)
X1 (use radio) 3 5 3
X2 (use newspaper) 1 -2 -2
Maximum (Y) 3 5 Maximum of minimums
(lower value of the
game)
Minimum of maximums
(upper value of the game)
“3” is called saddle point
2.Pure Strategy Games
• The strategy each player should follow will
always be the same regardless of the
other player’s strategy.
• A pure strategy exists whenever a saddle
point is present.
• A saddle point is a situation in which both
players are facing pure strategies.
Pure Strategy Games
• Example:
Y1 Y2 Minimum row
number (X)
X1 10 6 6
X2 -12 2 -12
Maximum
column number (Y) 10 6
Identify the saddle point.
The saddle point is 6.
3.Mixed Strategy Games
• When there is no saddle point, players will
play each strategy for a certain percentage
of the time.
• The goal of this approach is for a player to
play each strategy a particular percentage
of the time so that the expected value of
the game doesn’t depend upon what the
opponent does.
• This will only occur if the expected value of
each is the same.
Mixed Strategy Games
• Example:
Y1 Y2
P 1-P Expected gain
X1 Q 4 2 4P+2(1-P)
X2 1-Q 1 10 1P+10(1-P)
Expected gain 4Q+1(1-Q) 2Q+10(1-Q)
If player X chooses strategy X1, then P percent of the time the payoff
for Y will be 4 and 1-P percent of the time will be 2.
For player X, Q is the percentage of the time that strategy X1 is played
and 1-Q be the percentage of the time that strategy X2 is played.
Mixed Strategy Games
• If these expected values are the same then
the expected value for player Y will not
depend on the strategy chosen by X
4P+2(1-P) = 1P+10(1-P)
P = 8/11, 1-P = 3/11
• 8/11 and 3/11 indicate how often player Y
will choose strategies Y1 and Y2
respectively.
• The expected value with theses probabilities
is 38/11 = 3.46
Mixed Strategy Games
4Q+1(1-Q) = 2Q+1(1-Q)
Q = 9/11, 1-Q = 2/11
• 9/11 and 2/11 indicate how often player X
will choose strategies X1 and X2
respectively.
• The expected gains with theses
probabilities will also be 38/11 = 3.46
4.Dominance
• The principle of dominance can be used to
reduce the size of games by eliminating
strategies that would never be played.
• A strategy for a player is said to be
dominated if the player can always do as
well or better playing another strategy.
• Any dominated strategy can be eliminated
from the game.
Dominance
• Example:using the principle of dominance, we reduce the size
of the following game:
Y1 Y2
X1 4 3
X2 2 20
X3 1 1
In this game, X3 will never be played because X can always do
better by playing X1 or X2.
The new game is:
Y1 Y2
X1 4 3
X2 2 20
Dominance
• Example:using the principle of dominance, reduce the size of
the following game:
Y1 Y2 Y3
Y4
X1 -5 4 6 -3
X2 -2 6 2 -20
The new game is:
Y1 Y2
X1 -5 -3
X2 -2 -20
Questions
1. Bagles RUS is expanding into a high-growth suburban area. To
promote business and lure customers from the competing Wer
Bagel store, they are considering offering a free dozen bagels to the
first 50 customers or radio advertisement. The payoff for Bagels
RUS is given in the table below. What is Wer Bagels’ (Y) best
strategy?
Y1 Y2
X1 3 6
X2 2 -2
Questions
2. Bagles RUS is expanding into a high-growth suburban area. To
promote business and lure customers from the competing Wer
Bagel store, they are considering offering a free dozen bagels to the
first 50 customers or radio advertisement. The payoff for Bagels
RUS is given in the table below. What is the saddle point, if any, for
the bagel stores?
Y1 Y2
X1 3 6
X2 2 -2
Questions
3. George (player X) faces the following game. Using dominance,
reduce the size of the game if possible.
Y1 Y2
X1 6 5
X2 20 23
X3 15 11
Questions
4. Using the solution procedure for a mixed strategy game, solve the
following game:
Y1 Y2 Expected
gain
P 1-P
X1 Q 4 2 4P+2(1-P)
X2 1-Q 0 10 0P+10(1-
P)
