An Introduction to

GAME THEORY
for Managers

Sonia
sonia@iiml.ac.in
About the Course

Why do we need game theory,

…and what does it tell us?

• Focus on basic concepts

• Ideas and philosophy
…hidden behind mathematical models

• A few classroom games

 1944

O. Morgenstern J. von Neumann

… Ground-breaking text that created

the interdisciplinary research field
of Game Theory 2004
… The classic work upon which
modern-day game theory is based.
What is game theory?

Study of mathematical models of conflict and

cooperation between intelligent rational decision
makers

Strategic interactions between self interested people

…to analyze interactions as if they were games
Set of ideas and principles to guide strategic thinking

High applicability in various disciplines, social sciences,

humanities, engineering etc..
Social problem

In a ‘Social problem’
…You interact with others
What is best for you depends on what others do

Strategic Situation

Game theory constructs mathematical models to

examine how people behave in strategic situations
……Mathematics of human interactions

Individuals try to do their best against others

……Rational Players
 What game theory is NOT about?

Computer Games

Sorry! Game Theory is not about your favourite video games…

Defining Games - Key Ingredients

• Players: who are the decision makers?

People? Governments? Companies? Somebody
employed by a Company?...

• Actions/Strategies: what can the players do?

Enter a bid in an auction? Decide which route to
follow? Decide when to sell a stock?

• Payoffs: what motivates players?

Do they care about some profit? Do they care about
other players?...
What happens to the traffic flows if we construct a new bypass?

b City Y

City X
Players
= drivers commuting from City X to City Y
Strategies of each player
= {Route a, Route b,….}
Payoff to each player
= – traveling time
Games: Key Assumptions/ Observations

• Mathematically analyze a competitive situation.

… (War, Legal Battle, Marketing Strategy, IR Disputes, Elections)
• Complexity permits limited analysis.
• Simplifying assumptions.
• Neither player knows in advance the strategy of other, but both
know the set of strategies under consideration, and the payoff
matrix (Complete Information).
• In any given situation a decision-maker always chooses the
action which is the best according to his/her preferences
(rational play).
• Rational play is common knowledge among all players in the
game.
Example: Prisoners’ Dilemma

Two suspected robbers are interrogated in two different

rooms for the same crime. The dilemma is to confess or not.

Clyde

Silent Confess

Silent
Bonnie 1 year 10 years Set free

Confess
10 years Set free 5 years
Prisoners’ Dilemma: Payoff Table

Normal form representation:

Clyde

Silent Confess

Silent -1, -1 -10, 0

Bonnie

Confess 0, -10 -5, -5

Example: Battle of the sexes

… Shake Hands or Bow?

Player 2
Shake Bow
Hands

Shake
1, 2 0, 0
Player 1

Hands

Bow 0, 0 2, 1
Chicken Game

Becky

… Two players driving their Swerve Straight

cars towards each other (Chicken) (Tough)
… The first to swerve to
avoid a collision is the Swerve
looser (Chicken) 0, 0 -1, 1
Andy

… The one who kept

driving straight is the Straight
winner (Tough) 1, -1 -2, -2
Example: Matching Pennies

Player II

Head Tail

Head 1, -1 -1, 1
Player I

Tail -1, 1 1, -1

• This game is a Zero Sum Game, as the net gain of one

player is equal to the net loss of the other.
Location Game

A B

A’s customers

• Ice Cream Vendors A and B on a street

• Customers are uniformly distributed
• Each customer goes to the nearest vendor
… A and B at the same location 
they split the customers equally
• A vendor’s payoff = the numbers of customers
How to solve a game in normal form?

1. Dominance
2. Equilibrium solution
Dominance

In some games one strategy is uniformly better than

another.
Clyde
Silent Confess

Silent -1, -1 -10, 0

Bonnie

Confess 0, -10 -5, -5

Clyde ‘silent’  better to ‘confess’ for Bonnie

Clyde ‘confess’  again better to ‘confess’ for Bonnie
‘Confess’ is a dominant strategy
 or ‘Silent’ is dominated strategy.
 Or ‘Confess’ dominates ‘Silent’
Dominance

• One or both the players may have dominant strategies.

• When a strategy is dominated for one player, the other
player also knows it, and can remove it from
consideration.
• This can lead to dominance which was not there in the
original matrix.
• It may be possible to continue this process for several
steps. (Iterated Dominance)
• Sometimes all strategies except one will be eliminated by
this approach. The game is said to have been solved in
this case. (Dominance solvable games)
• Strong (>) vs weak dominance (≥)
Exercise

Player 2
x y z
Player 1 a 1, 2 2, 2 5, 1
b 4, 1 3, 5 3, 3
c 5, 2 4, 4 7, 0
d 2, 3 0, 4 7, 5

• Find all weekly and strongly dominated strategies for the

above game in normal form.
• The game is Dominance solvable.
• Final Strategy for Player 1: c
• Final Strategy for Player 2: y
Another exercise

• When Dominance Does not Solve the Game

Column
Left Middle Right

Top 3, 3 2, 3 10, 2
High 4, 5 3, 0 6, 4
Row

Low 2, 2 5, 4 12, 3
Bottom 5, 6 4, 5 9, 7

• ‘High’ is dominated by ‘Bottom’.

• No more domination.
• Dominance has not solved the game but reduced the size
of the problem
John Nash discovered the governing principle…

John Forbes Nash Jr.

(1928 – 2015)

Theorem of John Nash

Any Two-Person game (zero
sum or non-zero sum) with
a finite number of pure
strategies has at least one
equilibrium pair (Nash
equilibrium).
 Nash Equilibrium

When all players adopt a strategy where no single player, by

changing her strategy unilaterally, can obtain a better outcome.

Player 2

Left Middle Right

Top 3,3 2, 3 10, 2

High 4, 5 3, 0 6, 4
Player 1
Low 2, 2 5, 4 12, 3

Bottom 5, 6 4, 5 9, 7
How to find Nash equilibrium

Player 2

Left Middle Right

Top 3, 3 2, 3 10, 2

High 4, 5 3, 0 6, 4
Player 1
Low 2, 2 5, 4 12, 3

Bottom 5, 6 4, 5 9, 7
  Game: Guess 1/2 of the average 

• Rules:
…Each person has to guess a number between 0 to 100.
…The one whose number is closest to half of the average
numbers is the winner
…Do not discuss with each other
…Think thoroughly before you submit