GAME THEORY Game theory may be defined as “body of knowledge that deals with making decisions when two

or more intelligent & rational opponents are involved under conditions of conflict & competition” The approach of game theory is to seek to determine the rival’s most profitable counterstrategy to one’s own best moves & to formulate the appropriate defensive measures. For e.g. a price cut by one firm to capture the market, might invite similar reaction from second firm in the nature of price cut.

This will. in turn. affect the sales & profit of the former firm which will again have to develop a counter strategy to meet the challenges from the second firm. The players attempt to maximize gains & minimize losses. 3. 2. Each player has got a finite set of possible courses of action. the game will go on. Game theory helps in determining the best course of action for a firm in view of the expected counter moves from the competitor. The players act rationally & intelligently. . ASSUMPTIONS: 1. Thus.

we call it N person game. if the number of competitors is N (more than two). it is called two persons game. 3 Two persons zero sum game – When we assume two competitors playing a game. . 5 The players make individual decisions without direct communication. However. Basic Terminologies used in Game Theory 1 Player – Each participant is called a player 2 Play – When each player has chosen a course of action. 6 The pay-off is fixed & determined in advance. it is called play. 7 The players simultaneously select their respective courses of action.4 All relevant information are known to each player.

A game with two players where the gain of one player equals the loss of another player is known as ‘two persons zero sum game’. the interests of the two players are opposed in such a way that. The characteristics of two person zero sum game areOnly two players participate Each player has finite number of strategies to use Each specific strategy results in a specific payoff or outcome Total payoff of the two players at the end of each play is zero . their net gains are zero. In such a game.

. This net gain is measured in terms of the objective of the firm like increase in profit. Payoff matrix – This is the table showing the outcomes or payoffs of different strategies of the game. Payoff – The outcome of playing the game is known as payoff. expansion of market share etc.4 5 6 Strategy – strategy of the player is the predetermined rule by which he decides his course of action from his own list of courses of action during the game. It is the net gain the strategy brings to the firm for any given counter strategy of the competitor.

Any deviation from this strategy results in a decreased payoff for the player. irrespective of the strategy of his competitor is called an optimal strategy. .7 8 Optimal strategy – A course of action which puts the player in the most advantageous (preferred) positron. Value of the game – It is the expected payoff of the game or play when both the players of the game follow their optimal strategies. The game is called ‘fair’ if the value of the game is zero & ‘unfair’ if it is non-zero.

the maximizing player arrives at his optimal strategy on the basis of „maximin‟ criterion. Firm A has two strategies & firm B has three strategies & the corresponding payoffs are as under: .Process of determining optimal strategies & value of the game: Pure strategy game ( with saddle point): In case of pure strategy game. while the minimizing player’s strategy is based on „minimax‟ criterion. Illustration: Following is a two-person-zero-sum game.

B1 A1 Firm A A2 16 2 Firm B B2 B3 18 10 4 8 In the above matrix. then firm B chooses strategy B1 to minimize the payoff of firm A (payoff of 2). If firm A chooses strategy A1 to maximize its payoff (payoff of 18). . firm A is the maximizing player & firm B is the minimizing player.

When firm B plays B1 strategy. e. When firm A plays A2 strategy. Finding Maximin Value (for maximizing player/row player – firm A) 1. firm B plays B3 strategy to minimize the gain of A. Find the minimum value in each row & show it as row minima 2. maximin value is the maximum among these minimum values ( element 8) . A2 & B3 & the outcome of the game will be 8. firm A plays A2 strategy in order to maximize its gain. This strategy & counter strategy of players can be simplified with the help of „maximin & minimax‟ criteria. At this stage both A & B will stick to their respective strategy i.

both are same. i. Once saddle point exists for a game. . The saddle point is the solution or value of the game. Minimax value is the minimum value among these maximum values (element 8)  Saddle Point – In case the maximin value equals the minimax value. we get a saddle point. we can say what the optimal strategy would be for the two players & what is going to be the value of the game.Finding Minimax Value (for the minimizing player/column player – firm B) 1. Find the maximum value in each column & show it as column maxima 2.e. The saddle point in a payoff matrix is one which is the smallest value in its row & the largest value in its column.

Principle of dominance Principle of dominance is applicable to pure strategy as well as mixed strategy problems. then the latter strategy can be ignored since it will not affect the final solution in any way. it will give the final solution itself. it is used for simplifying the given problem. . whereas in case of mixed strategy game. In case of pure strategy game. This principle states that if a particular strategy of the player dominates over the other strategy in all conditions.

then the former row is said to be dominated by the latter i. If all the elements in a column are greater than or equal to corresponding elements in another column. the former column is said to be dominated by the latter i. the row player will never use the former strategy. the column player will never use the former strategy.e.Rules for dominance: If all the elements in a row are less than or equal to the corresponding elements in another row. .e. Dominated rows &/or columns may be deleted which reduces the size of the game. Always prefer dominance while solving a game with more than 2 strategies for a player.

obtain the optimum strategies for both the players & determine the value of the game. .Following is the payoff matrix for player A Player B I II III IV V I Player A II III 2 5 6 4 6 7 3 3 9 8 7 8 4 8 7 IV 4 2 8 4 3 Using dominance property.

Step 1: Since all the elements of row I are less than or equal to corresponding elements of row III. we can delete row I. The new payoff matrix will be as under Player B I II III IV V II Player A III 5 6 6 7 3 9 7 8 8 7 IV 4 2 8 4 3 Step 2: Since all the elements of row IV are less than the respective elements of row III. we can delete row IV & can rewrite the payoff matrix as under: .

we can delete column IV & column V.I Player B II III IV V II Player A III 5 6 6 7 3 9 7 8 8 7 Step 3: Since all the elements of column IV & column V are greater than or equal to corresponding elements in column I. In that case the payoff matrix will be as under: .

Player B I II III II Player A III 5 6 6 7 3 9 Step 4: All the elements of row II are less than corresponding elements of row III. The payoff matrix will be as under: . we can delete row II.

Row III Player B .I Player A III 6 Player B II III 7 9 In the above matrix.Column I . Thus the optimal strategies are – Player A . the column player B will never use strategies II & III because in that case A’s gain will be more than what it would be when he plays strategy I.