What is Game Theory? 
GT is an analytical tool for social sciences that is used to model strategic interactions or conflict situations.  Main objective  Competitor's control  Pay-offs & outcomes Strategic interaction: When actions of a player influence payoffs to other players

Influence factors 
rational behavior in interactive situations  Interests of individual player  Level of competition  Good strategist¶s own experience or prediction  Pay-offs & outcomes

How to use GT 
Explanation: What is the game to be played?  Prediction: What outcome will prevail?  Advice or prescription: Which strategies are likely to yield good results in which situations?

Why is GT important? 
Facilitates strategic thinking.  Provides a standard taxonomy that is needed for a scientific approach in analyzing strategic interactions.  Helps confirm long held beliefs.  Provides new insights.  ³To be literate in the modern age, you need to have a general understanding of GT.´ P.Samuelson

Where can we use GT? 
Any situation that requires us to anticipate our rival¶s response to our action is a potential context for GT.
± Games: Checkers, poker, chess, tennis, soccer etc. ± Economics: Industrial Organization, Micro/Macro/

± ± ± ±

International/Labor/Natural resource Economics, and Public Finance Political science: war/peace (Cuban missile crisis) Law: Designing laws that work Biology: animal behavior, evolution Information systems: System competition/evolution

Where can we use GT? (cont.) 
± Games against rival firms:
‡ Pricing, advertising, marketing, auctions, R&D, joint ventures, investment, location, quality, take over etc.

± Games against other players
‡ Employee/employer, managers/stockholders ‡ Supplier/buyer, producer/distributor, firm/government

What is a Normal Form Game?
A normal (strategic) form game consists of:  Players: list of players  Strategies: all actions available to all players  Payoffs: a payoff assigned to every contingency (every possible strategy profile as the outcome of the game)

Game Models 
Two persons zero-sum games: A gain by one is loss to other.  Non-zero sum game: gain by one not equal to the loss by other.  Saddle point game  Mixed strategy game  Dominance rule  2*n games & m*2 games  m*n games

Player¶s strategy A1 A2 A3 Column maxi-min

B! 12 6 -10 12

B2 -8 7 -6 7

B3 -2 3 2 3 -8 3

Raw mini-max


Saddle point : 3  Dominance rule

Assumptions in Static Normal Form Games 
All players are rational.  Rationality is common knowledge.  Players move simultaneously. (They do not know what the other player has chosen).  Players have complete but imperfect information.

International Investment Game 
3 Turkish firms investing in a Turkic Republic.  A new law is being debated in the Turkic Republic and they all want the law to be favorable for Turkish firms.  The president is very powerful. He promises to match the total donation made to a state university in terms of favorable tax cuts for Turkish firms.  The 3 firms have to decide whether to contribute or not.The more they contribute the more favorable the law.

International Investment Game
Firm 1 is the row player. Firm 2 is the column player. Firm 3 is the page player. Firm 3 Donates Firm 3 does not Donate Donate Don¶t Donate 5, 5, 5 3, 6, 3 Don¶t 6, 3, 3 4, 4, 1 Donate Don¶t Donate 3, 3, 6 1, 4, 4 Don¶t 4, 1, 4 2, 2, 2

NE is: (Don¶t, Don¶t, Don¶t)

What is a Game Tree?
Player 1

Player 2

Player 2





4 4

4 4

4 4

4 4

Assumptions in Dynamic Extensive Form Games 
All players are rational.  Rationality is common knowledge  Players move sequentially. (Therefore, also called sequential games)  Players have complete and perfect information
± Players can see the full game tree including the

payoffs ± Players can observe and recall all previous moves

Example of wall-mart to enter into foreign market




Enter Stay out Stay out 




Limitations of game theory 
There is no practical application of game theory in the real world  Assumptions of player & act rationality  Incomplete knowledge about competitor  Conservative approach to the decision

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