GAME THEORY

Charles Chege

Department of Physical and Mathematical Sciences

Mount Kenya University

March 23, 2020

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Learning Objectives

1 Define game theory.

2 Understand the possible areas of application of game theory.
3 Learn how to solve games with saddle points.
4 Learn how to solve games without a saddle point.

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Definition

Game theory is a mathematical technique of analyzing and solving

competing situations which arise out of conflicts of interests.

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Assumptions of a Competitive Game

1 The number of competitors is finite, say N.

2 A finite set of possible courses of action is available to each of
the N competitors.
3 A play of the game results when each of the players selects a
course of action from the set of courses available to them.
4 Each outcome of a play leads to a set of payments to each
player, which can be positive, negative or zero.

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Managerial applications of Game Theory

1 Analysis of the market strategies.

2 Evaluation of the responses of consumers to a new product.
3 Decision making on the techniques to increase market share.
4 Material procurement process
5 Examination of new business ventures.

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Key Concepts
1 Players; Competitors or decision makers in a game.
2 Strategies; Alternative causes of action available to a player.
3 Zero-sum game; A game in which the total pay-offs to all the
players at the end of the game is zero.
4 Maximin-Minimax principle; The maximum of the minimum
gains is called the maximin value of the game and the
corresponding strategy is called the maximin strategy.
Similarly the minimum of the maximum losses is called the
minimax value of the game and the corresponding strategy is
called the minimax strategy.
5 Saddle point; A point in the pay-off matrix where the
maximum of the row minima is equal to the minimum of the
column maxima.
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Illustration

Consider a 2x2 zero-sum game with each player having four

possible courses of action. This can be displayed in the following
table.
Player B Strategies
I II III IV
1 1 -6 8 4
Player A Strategies 2 3 -7 2 -8
3 5 -5 -1 0
4 3 -4 5 7

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 Find row minimums, [-6,-8,-5,-4], find the maximum out of this set
of minimums (-4) thus for player A maximin=-4
Find the column maximums, [5,-4,8,7], find the minimum out of
this set of maximums (-4), thus for player B minimax=-4
The game has a saddle point at -4
Value of the game V=-4
Optimal strategy for player A is 4 while for player B is II
Since the value of the game is negative, game is in favor of player B
NB: If value of the game was positive- game is in favor of player A
If V=0, game is fair.

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Example
Solve the game with the following pay-off matrix.
Player B Strategies
I II III IV V
1 9 12 7 14 26
Player A Strategies 2 25 35 20 28 30
3 7 6 -8 3 2
4 8 11 13 -2 1

Player A
Maximin [aij ]=max[7,20,2,-2]=20
player B
Minimax [aij ]=min[25,35,20,28,30]=20
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Example contd...

Saddle point is at (20)

value of the game=20
Optimal strategies for player A is 2, optimal strategy for player B is
III
Game is in favor of player A

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Games Without a Saddle Point
Consider the game with the following pay-off matrix;
Player B Strategies
I II
1 3 5
Player A Strategies 2 4 2

Row minimums, [3,2], maximum is 3

column maximums,[4,5], minimum is 4
Game has no saddle point.

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contd...

Under such circumstances, we use the expected value principle

under probability theory to solve the game.
If X is a random
P variable with density function P(X ), the expected
of X ; E (X ) = allx X ∗ P(X )

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General Case
The matrix above can be generalized into;
Player B Strategies
I II
1 a b
Player A Strategies 2 c d

If player A selects the first strategy then player B earns pay-off a

with probability p and pay-off b with probability 1 − p.
Thus the expected pay off is
E (pay − off ) = ap + b(1 − p) = ap + b − bp
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contd....
If player A selects strategy 2, the player B earns pay-off c with
probability p and pay-off d with probability 1 − p.
Thus, the expected pay-off is
E (pay − off ) = pc + d(1 − p) = pc + d − dp
Since the game is zero-sum, the expected values from both cases
should be equal.
Therefore; ap + b − bp = pc + d − dp (1)
We need to find an expression for p and 1 − p interms of a, b, c,
and d.
from (1) we have that;
p(a − b) − p(c − d) = d − b
d−b
p = (a−b)−(c−d)
d−b
(1 − p) = 1 − (a−b)−(c−d)
a−b−c+d−d+b
(1 − p) = (a−b)−(c−d)
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contd....
a−c
(1 − p) = (a−b)−(c−d)
On the other hand,
If player B selects strategy I, the player A earns pay-off a with
probability r and pay-off c with probability 1 − r .
Thus, the expected pay-off is
E (pay − off ) = ar + c(1 − r ) = ar + c − cr
If player B selects strategy II, the player A earns pay-off b with
probability r and pay-off d with probability 1 − r .
Thus, the expected pay-off is
E (pay − off ) = br + d(1 − r ) = br + d − dr
Since the game is zero-sum, the expected values from both cases
should be equal.
Therefore; ar + c − cr = br + d − dr (2)

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contd....
a−c
(1 − p) = (a−b)−(c−d)
On the other hand,
If player B selects strategy I, the player A earns pay-off a with
probability r and pay-off c with probability 1 − r .
Thus, the expected pay-off is
E (pay − off ) = ar + c(1 − r ) = ar + c − cr
If player B selects strategy II, the player A earns pay-off b with
probability r and pay-off d with probability 1 − r .
Thus, the expected pay-off is
E (pay − off ) = br + d(1 − r ) = br + d − dr
Since the game is zero-sum, the expected values from both cases
should be equal.
Therefore; ar + c − cr = br + d − dr (3)

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contd....

r (a − c) − (b − d) = d − c
d−c
r = (a−c)−(b−d)
d−c
1−r =1− (a−c)−(b−d)
a−c−b+d−d+c a−b
1−r = (a−c)−(b−d) = (a−c)−(b−d)

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Example

Solve the game with the following pay-off matrix.

Player B Strategies
I II
1 3 5
Player A Strategies 2 4 2

We already identified that this is a game without a saddle point!

From the general form, let a = 3, b = 5, c = 4 and d = 2

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Example Contd...

d−b 2−5 −3 3
Thus p = (a−b)−(c−d) = (3−5)−(4−2) = −4 = 4
1−p =1 − 34 = 14
E (Pay − off ) = ap + b(1 − p) = 3 ∗ 34 + 5 ∗ 14 = 94 + 54 = 14
4 = 3.5
Or equivalently;
E (pay − off ) = pc + d(1 − p) = 4 ∗ 34 + 2 ∗ 14 = 12 2
4 + 4 =
14
4 = 3.5

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Example Contd...

If player A selects strategies 1 and 2;

d−c
r = (a−c)−(b−d) 2−4
= (3−4)−(5−2) = −2
−4 =
1
2
1 − p = 1 − 12 = 12
E (Pay − off ) = ar + c(1 − r ) = 3 ∗ 12 + 4 ∗ 21 = 32 + 42 = 72 = 3.5
Or equivalently;
E (pay − off ) = br + d(1 − r ) = 5 ∗ 12 + 2 ∗ 21 = 52 + 22 = 72 = 3.5
Clearly, the value of the game is 3.5.
Game is in favor of player A and the game is a pure strategy.

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Exercise

Solve the game with the following pay-off matrix.

Player B Strategies
I II
1 -11 5
Player A Strategies 2 7 -9

Answers p = 12 , r = 7
16 , V = −2

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Learning Outcome Self-Assessment Questions

1 What is game theory?.

2 What should do to solve a game?.
3 What is a saddle point?.
4 What are the assumptions of a competitive game?.
5 What is expected value in probability theory?
6 How can I apply expected value in solving a game without a
saddle point?

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 THANK YOU

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