Game Theory

Game Theory

• Player
• Strategies
– Options available to the player
• Outcome (pay off)
– Pay off matrix
 Game Theory

B’s strategy
A’s strategy Maintain the price Cut price

Maintain the price 50, 50 40, 60

Cut price 60, 40 45, 45
 Game Theory

• Pay off matrix of firm A

B’s strategy
A’s strategy Maintain the price Cut price

Maintain the price 50 60

Cut price 40 45
 Game Theory
• Two person zero-sum game

Pay off matrix for firm A

B’s strategy
B1 B2 B3 B4 B5
A’s strategy

A1 0.10 0.20 0.15 0.30 0.25

A2 0.40 0.30 0.50 0.55 0.45
A3 0.35 0.25 0.20 0.40 0.50
A4 0.25 0.15 0.35 0.50 0.20
 Game Theory
• Equilibrium of the firm
– minimax-maximin combination
• Saddle point
– solution of the game
• Dominant strategy
– the strategy for which a player is getting
highest possible pay off, regardless of rival’s
action
• Dominated strategy
– a player yields a lower pay off than some
other strategy, regardless of rival’s action
 Game Theory

Dominant strategy of firm A

B’s strategy
B1 B2 B3 B4 B5
A’s strategy

A1 0.10 0.20 0.15 0.30 0.25

A2 0.40 0.30 0.50 0.55 0.65
A3 0.35 0.25 0.20 0.40 0.50
A4 0.25 0.15 0.35 0.50 0.20
 Game Theory
Pay off matrix for firm A
A’s B’s strategy
strategy P=5 P=3
Maximin = 80

P=5 90 50 Minimax = 80
P=3 150 80
Pay off matrix for firm B
A’s B’s strategy
strategy P=5 P=3
Maximin = 100
P=5 110 120 Minimax = 100
P=3 60 100
 Game Theory
Pay off matrix for firm A Pay off matrix for firm B
A’s B’s strategy A’s B’s strategy
strategy P=5 P=3 strategy P=5 P=3

P=5 90 50 P=5 110 120

P=3 150 80 P=3 60 100
Combined Pay off matrix
A’s B’s strategy
strategy
P=5 P=3

P=5 90, 110 50, 120

P=3 150, 60 80, 100
 Game Theory

• Nash equilibrium
– DEFINITION: If there is a set of strategies with the
property that no player can benefit by changing her
strategy while the other players keep their strategies
unchanged, then that set of strategies and the
corresponding payoffs constitute the Nash
Equilibrium.

– When both players have dominant strategy,

the solution to the game theory is Nash
equilibrium
 Game Theory
The prisoners' dilemma
B's strategies
Not confess Confess
A's
strategies
Each gets A gets 5 years
Not 1 year B gets 0 years
confess (1,1)
+* (5, 0)

A gets 0 years Each gets

Confess B gets 5 years 3 years
(0, 5) (3,3)
 Game Theory
The prisoners' dilemma
B's strategies
Not confess Confess
A's
strategies
Each gets A gets 5 years
Not 1 year B gets 0 years
confess (1,1)
+* (5, 0)

A gets 0 years Each gets

Confess B gets 5 years 3 years
(0, 5) (3,3)
 Game Theory
The prisoners' dilemma
B's strategies
Not confess Confess
A's
strategies
Each gets A gets 5 years
Not 1 year B gets 0 years
confess (1,1)
+* (5, 0)

A gets 0 years Each gets

Confess B gets 5 years 3 years
(0, 5) (3,3)