GAME THEORY: A TOOL FOR

DECISION-MAKING
 THE PROBLEM

Two suspects were

caught by the police
and interrogated in
separate rooms. Three
cases were presented to
them.
 THE PROBLEM

• CASE A: If only one of them confesses,

then one will go to jail for 1 year and the
other will go to jail for 25 years.
• CASE B: If neither of them confess, then
each will go to jail for 3 years.
• CASE C: If both of you confess, then
each will go to jail for 10 years.
THE PROBLEM
 THE PROBLEM
• If you are one of the two suspects, what are
you going to do in this scenario?

CONFESS OR
REMAIN SILENT
• What would be your “best” response and what
would be the other suspect’s best response?
 WHAT IS GAME THEORY?

GAME THEORY is the study of strategic

interaction between participants (players) in a
situation (games) that contains a set of rules
and a set of outcomes.
 WHAT IS GAME THEORY?

• It consists of a set of players and a set of

actions (moves) for each of them.
• A sequence of actions (moves) is called a
strategy.
• Each player receives a payoff that depends on
the actions of all the players involved.
 BASIC IDEA IN GAME THEORY

What would be the

player’s best strategy
to different moves of
the other players to
achieve the “best” or
maximum payoff?
SOME REAL-LIFE SITUATIONS WITH
GAME THEORY
• a person deciding which mode of
transportation to use
• businesses competing in a market
• sports game
• choosing where to eat
• food sharing and bill splitting
• species fighting for survival
 SOME CLASSIFICATION OF GAMES

• Simultaneous vs Sequential game

• Perfect vs Imperfect-Information Game
• Complete vs Incomplete-Information Game
 Simultaneous vs Sequential

Each player has only one move and all these

moves are done simultaneously.
 Simultaneous vs Sequential
No two players move at
the same time and
players may have
several actions (moves).
 Example 1: Simultaneous and
Sequential Games
Simultaneous Games:
Rock, Paper and Scissors Game, 1-2-3 Pass,
Prisoner’s Dilemma

Sequential Games:
Board Games, Poker and other card games
 Perfect vs Imperfect

A game is said to be of perfect-information if

each player, when making a decision, is perfectly
informed of all the actions that have previously
occurred. Otherwise, the game is of imperfect-
information.
Example 2: Games with Perfect and
Imperfect Information

Perfect-Information Games:
Chess, Monopoly, Tic-Tac-Toe

Imperfect-Information Games:
Games of the General, Cluedo, Prisoner’s
Dilemma
 Complete vs Incomplete

• In a game of complete-information, the

strategies, payoffs and player information are
common knowledge to all players.
• Otherwise, the game is said to be of
incomplete-information. Some players may
possess private information.
 NORMAL FORM
A game in normal form is a table of numbers
with the strategies listed along the margins of
the table and the payoffs for the participants in
the cells of the table.
Example 3: Normal Form of a Game
Construct the normal form of the Prisoner’s
dilemma game.
CASE A: If only one of them confesses, then one
will go to jail for 1 year and the other will go to
jail for 25 years.
CASE B: If neither of them confess, then each
will go to jail for 3 years.
CASE C: If both of you confess, then each will
go to jail for 10 years.
Example 3: Normal Form of a Game
Let C be “to confess” and R be “to remain silent”
Example 3: Normal Form of a Game
If both of you confess, then each will go to jail
for 10 years.
Example 3: Normal Form of a Game
If only one of them confesses, then one will go to jail for
1 year and the other will go to jail for 25 years.
Example 3: Normal Form of a Game
If only one of them confesses, then one will go to jail for
1 year and the other will go to jail for 25 years.
Example 3: Normal Form of a Game
If neither of them confess, then each will go to
jail for 3 years.
Example 4: Normal Form of a Game

Two companies share a market where they

make Php50 million each. They need to decide
whether they will advertise or not. Advertising
costs Php20 million, but captures Php30 million
in revenues from the competitor provided that
the competitor does not advertise. Construct
the normal form of this game.
Example 4: Normal Form of a Game
Let A be “to advertise” and N be “to not
advertise.
Example 4: Normal Form of a Game
If both companies would advertise

Company 1: 50M – 20M = 30M

Company 2: 50M – 20M = 30M
Example 4: Normal Form of a Game
If Company 1 advertises and Company 2 does
not advertise

Company 1: 50M – 20M + 30M = 60M

Company 2: 50M – 30M = 20M
Example 4: Normal Form of a Game
If Company 1 does not advertise and Company
2 advertises

Company 1: 50M – 30M = 20M

Company 2: 50M – 20M + 30M = 60M
Example 4: Normal Form of a Game
If both companies do not advertise

Company 1: 50M
Company 2: 50M
 EXERCISE: Normal Form of a Game
Anna and Belle have a lot of common friends but
the two of them are not on speaking terms. Both
want to invite their friends to a get-together this
weekend. The one who schedules the event on a
Saturday gets a payoff of 5 while a payoff of 4
goes to the one who schedules it on a Sunday. The
worst case scenario occurs when both set the get-
together on the same day. This has a payoff of -10
for both. Express the scenario in normal form.
 Analyzing Simultaneous Games in
Normal Form
• Games in normal form are used to analyze
one-shot games. Each player chooses one
action and all of them chooses
simultaneously.
• How do we decide? We can use the
following: Maximin Solution and Nash
Equilibrium.
 MAXMIN SOLUTION

• This solution involves

choosing the strategy that
gives you the maximum
among your worst
payoffs.
• This was proposed by the
mathematician John von
Neumann.
 Example 5: Maximin Strategy
WORKING ON A PROJECT GAME: You and your
classmate work together on a course
requirement and each of you can choose to
either work hard (W) or take it easy (T). You
both want to pass but both of you do not like
working very hard. Assume that the two of you
would meet tomorrow to combine your
outputs. Determine the your and your
classmate’s maximin strategy.
 Example 5: Maximin Strategy
The payoff matrix is shown below and the
payoff values represent “happiness” or
“satisfaction” levels.
 Example 5: Maximin Strategy
Step 1: Separate the payoff values of each
player into two matrices.
 Example 5: Maximin Strategy

Step 2A: Determine the maximin strategy of

the row player. To do this, highlight the worst
payoff in each row. Among the highlighted
payoff values of the row player, determine the
maximum. The strategy corresponding to this
maximum value is the maximin strategy of the
row player.
Example 5: Maximin Strategy
 Example 5: Maximin Strategy

Step 2B: Determine the maximin strategy of the

column player. To do this, highlight the worst
payoff in each column. Among the highlighted
payoff values of the column player, determine
the maximum. The strategy corresponding to
this maximum value is the maximin strategy of
the column player.
Example 5: Maximin Strategy
 Example 5: Maximin Strategy

Step 3: If both players have a maximin strategy,

then the game has a maximin solution. We
write it as an ordered pair or strategy pair (A,B)
where A and B are the maximin strategies of
the row and column player, respectively.
 Example 5: Maximin Strategy

For the working on a project game, the

maximin solution is (Take it Easy, Take it Easy).
This solution leads to the payoff pair (1,1).
 Example 6: Maximin Strategy
BATTLE OF THE SEXES: Suppose, on a given night, a
husband can either watch a sports program or a TV
series. The husband prefers the sports program
while his wife prefers the TV series. The worst
possible thing to happen would be to have an
argument and not watch together, or at all. What
should the husband do? Determine the maximin
solution of this game.
 Example 6: Maximin Strategy

For the husband,

For the wife,

 Example 6: Maximin Strategy

Since at least one of the players (husband or

wife) does not have a maximin strategy, the
battle of the sexes game does not have a
maximin solution.   
 EXERCISE: Maximin Strategy

Determine the maximin solution of the

Prisoner’s dilemma game, if it exists.
 NASH EQUILIBRIUM
• A Nash equilibrium is a strategy for each
player such that every players’ action is the
best response to the other players’ actions.
• Each player is using his best response in the
game. So, switching into another strategy
would result into a lower payoff.
• In other words, no player can reach a better
payoff by changing strategies.
 NASH EQUILIBRIUM

This solution concept was

named after John Forbes
Nash, Jr. His theories are
used in economics, and in
fact he won the Nobel Prize
for Economic Sciences in
1994.
 Example 7: Nash Equilibrium
Let us consider again the normal form of the
Working on a Project Game. Determine any
Nash Equilibrium of this game.
 Example 7: Nash Equilibrium

Steps to determine the Nash Equilibrium:

Step 1: Determine the best response of the row
player to every strategy of the column player.
To do this, underline the highest payoff value
among the first coordinates of the ordered
pairs in each column. If there are ties,
underline all.
 Example 7: Nash Equilibrium

Step 2: Determine the best response of the

column player to every strategy of the row
player. To do this, underline the highest payoff
value among the second coordinates of the
ordered pairs in each row. If there are ties,
underline all.
 Example 7: Nash Equilibrium

Step 3: If there are ordered pairs with both

coordinates underlined, then the game has a
Nash Equilibrium.
 Example 7: Nash Equilibrium

What would be your best response if your

classmate would work hard?
 Example 7: Nash Equilibrium

What would be your best response if your

classmate would take it easy?
 Example 7: Nash Equilibrium

What would be your classmate’s best response

if you would work hard?
 Example 7: Nash Equilibrium

What would be your classmate’s best response

if you would take it easy?
 Example 7: Nash Equilibrium

The Nash Equilibrium is (Take it Easy, Take it

Easy) and the payoff ordered pair is (1,1).
 Example 8: Nash Equilibrium
Let us consider again the normal form of the
Battle of the Sexes Game. Determine any Nash
Equilibrium of this game.
 Example 8: Nash Equilibrium
What would be the husband’s best response if
the wife chooses sports program?
 Example 8: Nash Equilibrium
What would be the husband’s best response if
the wife chooses TV Series?
 Example 8: Nash Equilibrium
What would be the wife’s best response if the
husband chooses TV Series?
 Example 8: Nash Equilibrium
What would be the wife’s best response if the
husband chooses TV Series?
 Example 8: Nash Equilibrium
The Nash Equilibria are (Sports, Sports) and (TV
Series, TV Series). The solution leads to the
payoff pairs (2,1) and (1,2).
 EXERCISE: Nash Equilibrium
Consider again the normal form of the
Prisoner’s dilemma game. Determine any Nash
Equilibrium.
 Dominating vs Dominant Strategy

• Suppose that A and B are strategies of the

row (column) player. We say that “A is
dominating B” or “B is dominated by A” if it
outperforms B regardless of the strategies
chosen by the opposing player(s).
• We say that A is a dominant strategy of the
row (column) player if it is dominating all the
other strategies of the row (column) player.
 Example 9: Dominant Strategy
Consider the following normal form of a game.
Determine any dominant strategy for both
players.
 Example 9: Dominant Strategy
Separating the payoff values of the row and
column players, we get the following:
 Example 9: Dominant Strategy
For the row player, A3 is dominating A1 and A2.
Thus, A3 is a dominant strategy of the row
player. Thus, the row player has a dominant
strategy. Observe that A2 is dominating A1 but
does not dominate A3. Hence, A2 is not a
dominant strategy.
 Example 9: Dominant Strategy
For the column player, B2 is dominating B1 and
B3 is also dominating B1. However, neither of
them is a dominant strategy because they don’t
dominate all the other strategies. Thus, the
column player does not have a dominant
strategy.
 Example 10: Dominant Strategy
Consider the following game in normal form.
Determine if there are any dominant strategy
for each player.
 Example 10: Dominant Strategy
Let us consider Kiko’s payoff values:

Hence, Kiko’s dominant strategy is B.

 Example 10: Dominant Strategy
Let us consider April’s payoff values:

Hence, April’s dominant strategy is F.

Dominant Strategy Equilibrium

A game in normal form has a dominant strategy

equilibrium if both players have dominant
strategies.
 Example 11: Dominant Strategy
Equilibrium
With reference to Example 10, the dominant
strategy equilibrium of the game is (B,F).
 Iterative Elimination of Dominated
Strategies

• This method can be used to find any Nash

Equilibrium of a game.
• An algorithm that removes any dominated row
(column) strategies in the game.
• Reduces the number of strategies/outcomes to
be considered in the game.
 Example 12
Consider the following normal form of a game.
Use IEDS to reduce this game and find any Nash
Equilibrium.
 Example 12
Separating the payoff values of Mr. M and Mr. G:
 Example 12
Removing strategy C for both tables, we get:
 Example 12
Removing strategy F for both tables, we get:
 Example 12: IESDS
The reduced payoff table is as follows:

There are two Nash Equilibria: (B,A) and (A,B).

 Games in Extensive Form
A game in extensive form is a tree diagram in
which each strategic decision is shown as a
branch point.
 Example 13: Extensive Form
An incumbent local government official runs
against a challenger. They are contemplating on
which position to take regarding an issue of
importance. The incumbent chooses first. If
both choose the same position, the incumbent
wins. Otherwise, the challenger wins. Assume
that the payoff for winning is 10, the value of
choosing a position not consistent with their
party platform is -5 and the payoff is the sum of
the values obtained. Draw the extensive form.
 Example 13: Extensive Form
The incumbent chooses first. If
both choose the same position,
the incumbent wins. Otherwise, I
the challenger wins.
P N

C C
P N P N

(10,0) (0,5) (-5,10) (5,-5)

Assume that the payoff for winning is 10, the value of choosing a position not
consistent with their party platform is -5 and the payoff is the sum of the values
obtained.
 Analyzing Sequential Games in
Extensive Form
• Extensive form games are suitable for
sequential decision-making.
• In analyzing games in extensive form, we
breakdown the tree diagram to form
subgames.
• A subgame includes a decision point and all
the other parts emanating from it.
 Example 14: Subgame
Consider the game whose extensive form is as
follows. Determine all the subgames of this
game tree.
 Backward Induction

• Step 1: Solve the subgames at the last stage

in each branch to reduce the game into a
smaller one.
• Step 2: We repeat until all subgames have
been solved.
• Step 3: The resulting tree diagram gives the
equilibrium solution.
 Example 16: Backward Induction
Find the backward induction solution of the
following game:
EXERCISE: Backward Induction
List of Games
List of Games
List of Games