GAME THEORY

INTRODUCTION

Life is full of conflict and competition. Some examples are parlour games, war, political
campaigns, advertising and marketing by business firms. Game theory is a mathematical
theory that deals with conflict situations like these.

Basic characteristics of a game.

In a game:

There are at least two players

Each player wants to win
The winner will get a payoff
Players compete with each other
Cooperation is not an advantage
Rules of the game are clearly defined and known to all players, in advance
Each player has a finite set of possible strategies
The outcome of the game depends on the strategies chosen by each player

Game theory is the study of how players should rationally play games. Each player would like
the game to end in an outcome which gives him as large payoff as possible. The four main
components that interact with each other in a game are players, strategies, outcome and
payoffs.

Games are defined by,

a) The number of players. When there are two players it is called a two person game. When
there are n players it is called an n person game etc.

b) The net winnings of the game. A zero sum game is where the net winnings is zero. For
example in a two person zero sum game what one player wins the other looses.

c) Fairness of the game. A game which is not biased toward any player is called a fair game.
A game in which a given player can always win by playing correctly is therefore called an
unfair game.

FORMULATION OF A TWO PERSON ZERO SUM GAME

A two person zero-sum game is one in which the payoffs add up to zero. They are strictly
competitive in that what one player gains the other loses. The game obeys a law of
conservations of utility value, where utility value is never created or destroyed, only
transformed from one player to another.

To illustrate the basic characteristics of a two person zero sum game consider the following
game.

Odds and evens: Each player simultaneously shows one finger or two. If the number of
fingers match player 1 receives Rs 1 from player 2, otherwise player 2 receives Rs 1 from
player 1.

In this game each player has two strategies. To show one finger or two. Table 1 shows the
payoff table for player 1. In general a two person game is characterised by

Strategies of player 1
Strategies of player 2
The payoff table
In a two person zero sum game the payoff table shows the payoff to player 1. Payoff to player
2 is just the negative of this one.

Player2
Strategy 1 2
1 1 -1
Player1 2 -1 1

Table 1: Payoff table for odds and evens game

Games with saddle points

Let us consider the game shown in Table 2.

Player2 Minimum
Strategy 1 2 3
1 -3 -2 6 -3
Player 1 2 2 0 2 0 Maximin
3 5 -2 -4 -4

Maximum 5 0 6
Minimax

Table 2: Payoff table for player 1

How does player 1 analyse the payoff table to select the best strategy? One option is to use
the maximin principle, where each player choses the strategy which contains the best of the
worst possible outcomes. In other words, the player choses to maximise the minima and
guarantee that the payoff will be less than player1’s maximin value.

Player 2 is also making a strategic decision using the same logic. Player 2 is trying to
minimise player1’s maxima. That is player 2 is adopting a minimax principle.

In this example minimax=maximin=0. They coincide. When they coincide the game has a
saddle point which is also called an equilibrium point. The players can only do worse, never
by selecting a strategy other than the saddle point strategy. This situation where the players
always play one strategy is called a pure strategy.

Dominance

A strategy S dominates strategy T if every outcome in S is at least as good as the

corresponding outcome in T, and at least one outcome in S is strictly better than the
corresponding outcome in T. A player should never play a dominated strategy.

A B C D
A 12 -1 1 0
B 5 1 7 -20
C 3 2 4 3
D -16 0 0 16

Table 3: A game with a dominated strategy

Consider the game shown in table 3. All the numbers in column 2 are less than or equal to
numbers in column 3. We say player2’s strategy B dominates strategy C, or strategy C is
dominated by strategy B.

Mixed strategies
Consider the following game.

A B Row Minimum
A 2 -3 -3
B 0 3 0 Maximin

Col
Maximum 2 3

Minimax

Table 4: A game without a saddle point

In this game minimax is not equal to maximin. Which means there is no saddle point. Here
neither player would want to play a pure strategy, because the other player would take
advantage of such a choice. The only sensible plan is to use some random device to decide
which strategy to play. For example player 1 might flip a coin to decide between strategies A
and B. Such a plan, which involves playing a mixture of strategies according to a certain fixed
probabilities is called a mixed strategy.

The effect of one or both players using mixed strategies can be analysed using the concept of
expected value.

The expected value of getting payoffs a1, a2, a3, ……..ak with respective probabilities p1, p2, p3
……pk is p1a1 + p2a2 + p3a3 + ………+pkak.

You will notice that the expected value of a set of payoffs is just the weighted average of
those payoffs, where the weights are the probabilities that each will occur. If player 2 uses the
coin flipping strategy for the game shown in Table 4, she will play strategy A with probability ½
and strategy B with probability ½. Hence if player 1 plays strategy A, he will get a payoff of 2
with a probability of ½ and -3 with a probability of ½ Thus player 1’s expected payoff is ½(2)+
½ (-3) = - ½ . Similarly if player1 plays strategy B the expected payoff is
½(0)+ ½(3) = 1½. It is clear that if player1 knows that player 2 is playing the mixed strategy
½ A, ½ B he should play strategy B. This reasoning is known as the

Expected Value Principle. If you know that your opponent is playing a given mixed strategy,
and will continue to play regardless of what you do, you should play your strategy which has
the largest expected value.

Now consider the situation from Player2’s point of view. If he use the mixed strategy
½ A, ½ B player 2 can take advantage of the situation and get a payoff of 1½. Player2 might
consider using a different mixed strategy. There might be some choice of probabilities where
player1 could not take advantage of ?

Assume that Player2 plays a mixed strategy with probabilities x for A, (1-x) for B, where x is a
number between 0 and 1. Player1’s expected payoffs for strategies A and B are,

A: x(2) + (1-x)(-3) = -3 + 5x
B : x(0) + (1-x)(3) = 3 -3x

Player1 will not be able to take advantage of Player2’s mixed strategy, if these two expected
values are the same. Equating these two expected values we get x= ¾ . If player2 plays a
mixed strategy ¾ A , ¼ B he can assure that Player1 wins, on the average no more than ¾
per game. Player1s payoffs for strategies A and B are,

A: ¾ (2) + ¼ (-3) = ¾
B: ¾ (0) + ¼ (3) = ¾
Now consider this game from Player1’s point of view. In trying to find a mixed strategy in
which Player2 cannot take advantage of, Player1 does a similar calculation.

A: x(2) + (1-x)(0) = 2x
B: x(-3) + (1-x)(3) = 3-6x

Equating these two expected payoffs we get x= 3/8. If player1 plays a mixed strategy 3/8 A,
5/8 B, he is assured winning, on the average , at least ¾ regardless of how Player2 plays.

A: 3/8(2) + 5/8(0) = ¾
B: 3/8(-3) + 5/8(3) = ¾

So the solution of this game is

• ¾ is the value of the game
• ¾ A, ¼ B Player2’s optimal strategy
• 3/8 A, 5/8 B Player1’s optimal strategy

Every game has such a solution either in pure strategy or in mixed strategy.