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Game Theory: A brief introduction

Presented by Scott Corwon, IMPACTS

The purpose of the IMPACTS presentation series is to effectuate

knowledge transfer concerning topical mathematical and scientific
issues. Significant published works form the basis for much of the
ppresentation series, and these works are interpreted
p and ppresented
by recognized leaders in the topic area. The presentation series is
made possible through the generous support of IMPACTS.
Game Theory

“ If it’s true that we are here to help others,

then what exactly are the others here for? ”
- George Carlin
What is Game Theory?
y Game Theory: The study of situations involving competing interests,
modeled in terms of the strategies, probabilities, actions, gains, and losses
of opposing players in a game. A general theory of strategic behavior with a
common feature of Interdependence.

y In other Words: The study of games to determine the probability of

winning, given various strategies.

y Example: Six people go to a restaurant.

- Each person pays for their own meal – a simple decision problem
- Before the meal, every person agrees to split the bill evenly among them – a game
A Little History on Game Theory
y John von Neumann and Oskar Morgenstern
- Theory
Th off Games
G andd EEconomic BBehaviors
ƒ John Nash
- "Equilibrium points in N-Person Games", 1950, Proceedings of NAS.
"The Bargaining Problem", 1950, Econometrica.
"Non-Cooperative Games", 1951, Annals of Mathematics.
ƒ Howard W.
W Kuhn – Games with Imperfect information
ƒ Reinhard Selten (1965) -“Sub-game Perfect Equilibrium" (SPE) (i.e.
elimination by backward induction)
ƒ John C. Harsanyi - "Bayesian Nash Equilibrium"
Some Definitions for Understanding
Game theory
y Players-Participants of a given game or games.

y Rules-Are the guidelines and restrictions of who can do what and when they can do it
within a given game or games.

y Payoff-is
P ff i theh amount off utility
ili (usually
( ll money)) a player
l wins
i or lloses at a specific
ifi stage
of a game.

y Strategy-
gy A strategy
gy defines a set of moves or actions a player
p y will follow in a given
game. A strategy must be complete, defining an action in every contingency, including
those that may not be attainable in equilibrium

y Dominant Strategy
gy -A strategy
gy is dominant if,, regardless
g of what anyy other players
p y
do, the strategy earns a player a larger payoff than any other. Hence, a strategy is
dominant if it is always better than any other strategy, regardless of what opponents may
Important Review Questions for Game
ƒ Strategy
St t
y Who are the players?
y What strategies are available?
y What are the payoffs?

y What are the Rules of the game

y What is the time-frame for decisions?
y What is the nature of the conflict?
y What is the nature of interaction?
y What information is available?
Five Assumptions Made to Understand
Game Theory
1. Each decision maker ("PLAYER“) has available to him two or more well-specified
choices or sequences of choices (called "PLAYS")

2. Every possible combination of plays available to the players leads to a well-defined

end-state (win, loss, or draw) that terminates the game.

3. A specified payoff for each player is associated with each end-state (a ZERO-SUM
game means that the sum of payoffs to all players is zero in each end-state).

4. Each decision maker has perfect knowledge of the game and of his opposition; that is,
he knows in full detail the rules of the game as well as the payoffs of all other players.

5. All decision makers are rational; that is, each player, given two alternatives, will select
the one that yields him the greater payoff.
Cooperative Vs.
Vs Non-Cooperative
Non Cooperative
y Cooperative Game theory has perfect communication
andd perfect
f contract enforcement.

ƒ A non-cooperative
ti game is
i one in
i which
hi h players
l are
unable to make enforceable contracts outside of those
p y modeled in the ggame. Hence, it is not defined
as games in which players do not cooperate, but as games
in which any cooperation must be self-enforcing.
I t d
d off Player
Pl Strategies
St t gi
1) Sequential – Here the players move in sequence, knowing
the other players’ previous moves.
- To look ahead and reason Back
2) Simultaneous
S l – Here
H the h players
l act at the
h same time, not
knowing the other players’ moves.
- Use Nash Equilibrium to solve
Simultaneous-move Games of Complete

ƒ A set of players (at least two players)

S1 S2 ... Sn

„ For each p
y , a set of strategies/actions
g /
{Player 1, S1, Player 2,S2 ... Player Sn

y Payoffs received by each player for the combinations of the

strategies, or for each player, preferences over the combinations
of the strategies
ui(s1, s2,, for all s1∈S1, s2∈S2, ... sn∈Sn
Nash’s Equilibrium
y This equilibrium
q occurs when each player’s
p y strategy
gy is optimal,
p , knowingg
the strategy's of the other players.

y A player’s best strategy is that strategy that maximizes that player’s payoff
(utility), knowing the strategy's of the other players.

y So when each player within a game follows their best strategy, a Nash
equilibrium will occur.

Logic Logic
Definition: Nash Equilibrium
In the normal-form
normal form game {S1 , S2 , ..., Sn , u1 , u2 , ...,
un}, a combination of strategies (s1*,...,sn* ) is a Nash
equilibrium if, for every player i, G e others’
Given ot e s
ui (s1*,...,si*−1, si*, si*+1,...,sn* ) choices, player i
cannot be better-off
≥ ui (s1*,...,si*−1, si , si*+1,...,sn* ) if she deviates from
si *
for all si ∈ Si . That is, si* solves
Maximize ui (s1*,...,si*−1, si , si*+1,...,sn* )
Subject to si ∈ Si
Nash’s Equilibrium cont.:
i N
h Equilibrium
E ilib i
y The Nash Equilibrium of the imperfect-information game

y A Bayesian Equilibrium is a set of strategies such that each player is

p y g a best response,
playing p ggiven a pparticular set of beliefs about the move
by nature.

y All p
y have the same pprior beliefs about the pprobabilityy distribution
on nature’s moves.
– So for example, all players think the odds of player 1 being of a particular type is p,
and the probability of her being the other type is 1-p
’ Rule
R l
• A mathematical rule of logic explaining how you should change
your beliefs
b li f in
i light
li ht off new information.
i f ti

• Bayes
Bayes’’ Rule:
P(A|B) = P(B|A)*P(A)/P(B)

• To use Bayes
Bayes’’ Rule,
Rule you need to know a few things:
– You need to know P(B|A)
– You also need to know the probabilities of A and B
Examples of Where Game
Theo Can Be Applied
y Zero-Sum Games
y Prisoner’s Dilemma
y Non-Dominant Strategy moves
y Mixing Moves
y Strategic Moves
y Bargaining
g g
y Concealing and Revealing Information
Zero-Sum Games
Penny Matching:
y Each of the two players has a penny.

y Two players must simultaneously choose whether to show the Head or the Tail.

y Both
B h players
l kknow the
h ffollowing
ll i rules:
-If two pennies match (both heads or both tails) then player 2 wins player 1’s penny.
-Otherwise, player 1 wins player 2’s penny.

Player 2
Head Tail
Head -1 , 1 1 , -1
Player 1
Tail 1 , -1 -1 , 1
Prisoner’s Dilemma
y No communication:
- Strategies must be undertaken without the full
knowledge of what the other players (prisoners) will do.

ƒ Players (prisoners) develop dominant strategies but are not

necessarily the best one.
Payoff Matrix for Prisoner’s Dilemma
Confess Not Confess

1 year for
Both g
get 5 Bill
years 10 years for
Bill Ted
10 years for
Not Confess Bill Both g
get 3
1 year for years
Solving Prisoners’ Dilemma
y Confess is the dominant strategy for both Bill and Ted.

y D
Dominatedd strategy
-There exists another strategy which always does better regardless of other players’
-(Confess Confess) is a Nash equilibrium but is not always the best option

Players Ted
Strategies C f
Confess Not Confess

Bill Confess -5, -5 -1,-10

Not Confess -10
,-1 -3,-3
Non Dominant strategy games
y There are manyy games
g when players
p y do not have dominant strategies

- A player’s strategy will sometimes depend on the other player's


- According to the definition of Dominant strategy,

strategy if a player depends
on the other player’s strategy, he has no dominant strategy.
Non Dominant strategy games


Confess Not Confess

7 years for Bill 6 years for Bill

2 years for Ted 4 years for Ted
9 years for Bill 5 years for Bill

Not Confess 0 years for Ted 3 years for Ted

Solution to Non-Dominant
st ateg games
Ted Confesses Ted doesn’t confess
Bill Bill

Confesses Not confess Confesses Not confess

7 years 9 years 6 years 5 years

Best Strategies

There is not always a dominant strategy and sometimes

your best strategy will depend on the other players
Examples of Where Game
Theo Can Be Applied

ƒMixing Moves
ƒExamples in Sports (Football & Tennis)
ƒStrategic Moves
ƒWar –Cortes Burning His Own Ships
ƒSplitting a Pie
ƒConcealing and Revealing Information
ƒBluffing in Poker
Applying Game Theory to NFL
y Solving a problem within the Salary Cap.
y How should each team allocate their Salary cap. (Which
position should get more money than the other)
y The Best strategy is the most effective allocation of the
team’s money to obtain the most wins.
y Correlation can be used to find the best way to allocate
the team’s money.
What is a correlation?
y A correlation examines the relationship
p between two measured
- No manipulation by the experimenter/just observed.
- E.g., Look at relationship between height and weight.
y You can correlate any two variables as long as they are numerical
((no nominal
i l variables)
i bl )
y Is there a relationship between the height and weight of the students
in this room?
- Of course! Taller students tend to weigh more.
Salaries vs
vs. Points scored/Allowed
Position Correlatio T-test Position Correlatio T-test
n n
RB .27 2.67 DE .25 2.52
k .25 2.52 CB .15 1.48

TE .17
17 1 74
1.74 S .06
06 .61

OL .04 .34 LB .05 .52

QB .03 .32 DT .04 .34

WR -.03 -.30 P 0 0

Running Backs edge out Kickers for best correlation of position

spending to team points scored. Tight Ends also show some
modest relationship between spending and points.
The Defensive Linemen are the top salary correlators,
correlators with
cornerbacks in the second spot
Total Position spending vs.
vs Wins
Position Wins Points Scored Points Allowed Total Position

Correlation Correlation Correlation Spending

K 0.27 0.27 0.17 0.27
CB 0.17 0.12 0.12 0.23
TE 0.16 0.2 0.15 0.17
OL 0.15 0.02 0.2 0.08
RB 0.11 0.11 -0.03 0.26
QB 0.1 0.08 0.08 0.04
DE 0.08 -0.14 0.17 0.16
P 0.08 0.01 0.03 0.04
LB 0.05 -0.08 0.15 -0.02
S 0.03 0.02 0.05 0.04
DT -0.02 -0.01 0.02 -0.04
WR -0.08
0 08 -0.01
0 01 -0.04
0 04 0 01

Note: Kicker has highest correlation also OL is ranked high also.

What this means
y NFL teams are not very successful at delivering results for
the big money spent on individual players.

y There's
Th ' high
h h riskk in general,
l bbut more so at some positions
over others in spending large chunks of your salary cap space.
Future Study
y Increase the Sample size.
y Cluster Analysis
y Correspondence analysis
y Exploratory Factor Analysis
ƒ There are many advances to this theory to help describe and
prescribe the right strategies in many different situations.
ƒ Although the theory is not complete, it has helped and will
continue to help many people,
people in solving strategic games.
y Nasar, Sylvia (1998), A Beautiful Mind: A Biography of John Forbes Nash, Jr.,Winner of the Nobel Prize
in Economics, 1994. Simon and Schuster, New York.
y Rasmusen, Eric (2001), Games and Information: An Introduction to Game Theory, 3rd ed. Blackwell,
y Gibbons, Robert (1992), Game Theory for Applied Economists. Princeton University Press,
Princeton NJ.
Princeton, NJ
y Mehlmann, Alexander. The Games Afoot! Game Theory in Myth and Paradox. AMS, 2000.
y Wiens, Elmer G. Reduction of Games Using Dominant Strategies.Vancouver: UBC M.Sc. Thesis,
y H. Scott Bierman and Luis Fernandez (1993) Game Theory with Economic Applications, 2nd ed.
(1998), Addison-Wesley Publishing Co.
y D. Blackwell and M. A. Girshick (1954) Theory of Games and Statistical Decisions, John Wiley &
Sons, New
N Y York.
y NFL Official, 2004 NFL Record and Fact Book; Time Inc. Home Entertainment, New York,
New York.
Game Theory

“ If it’s true that we are here to help others,

then what exactly are the others here for? ”
- George Carlin