Quantitative

methods for
business
Lecture 2.1: Game Theory
Our Objectives:

1. Understand the principles of zero-sum, two-player game

2. Analyzing pure strategy game, dominance principle.

3. Solve mixed strategy games.

 WHAT IS A GAME?
At least two players

Payoffs
 WHAT IS GAME THEORY?
The study of problems of how optimal strategies are
formulated in conflict and cooperation among
independent decision-makers.

The game theory includes:

* PLAYERS (decision-makers)
* CHOICES, STRATEGIES (feasible
actions)
* PAYOFFS (consequences, gains or
losses, benefits, prizes, or awards)
* PREFERENCES TO PAYOFFS
(objectives)
THE VALUE OF THE GAME
• Value of the game: the expected payoff when all players
follow their optimal strategies.

• Payoff matrix: When the players select their particular

strategies, the payoffs (gains or losses) can be presented
in the form of a matrix.
Zero sum, two-player games

1. A game which only involves two players

2. A participant's win or loss is exactly balanced by the loss or win of
the other participant.
Zero sum, two-player games
Example

Payoff table for player A.

B’s strategies
B1 B2 B3

A’s A1 4 5 -4
strategies
A2 -2 3 -1

A3 3 -7 5

If player A plays strategy A2 and B plays B2 then A

wins 3 while B losses -3
Strategies for zero-sum, two player games

Dominated Pure strategy Mixed Strategy

strategy • Both players will • The optimal strategy
• A procedure that is always play just one for both players
used to reduce the size strategy. involves playing more
of the game. than one strategy over
time. Each strategy is
played a given
percentage of the time.
 Dominated strategy
• A strategy is dominated if the player can always do as
well or better playing another strategy.
• The principle of dominance: reduce the size of games
by eliminating strategies that would never be played.
If you are player X

Example If you are player Y

Dominated strategy

Strategies of Player A
A1 A2 A3 A4 A5
Strategies B1 6 5 1 -1 -2
of Player B
B2 4 -5 0 -3 3
B3 4 7 1 0 3
B4 1 2 0 -1 0

What is the best strategies for

each player?
 Pure Strategy: Both players will always play just one
strategy throughout the game.
 Minimax criteria: the strategy that minimizes the maximum loss.
 Maximin criteria: the strategy that maximizes the minimum gain.

 The upper value of the game: equal to the minimum of the maximum values in
the columns.
 The lower value of the game: equal to the maximum of the minimum values in
the rows.
 An equilibrium or a saddle point exists if the upper value of the game is equal to
the lower value of the game. This is called the value of the game.

Example
 Pure Vs mixed strategies

• A pure strategy: Both •A mixed strategy: Each

players will always play just strategy is played a given
one strategy throughout the percentage of the time.
game. • The saddle point doesn’t exist
• The saddle point exists
Solve Mixed strategy games
Step 1:
- For player Y: let P be the probability that player Y chooses strategy Y1 and (1-P) be the probability that player Y chooses strategy Y2
- For player X: let Q be the probability that player Y chooses strategy X1 and (1-Q) be the probability that player Y chooses strategy X2
Solve Mixed strategy games

Step 2:
Solve for P, Q and calculate the expected gains with these probabilities for player X and player Y.
 Solve Mixed strategy games
For player X
Set the expected gains equal, we
obtain:
4Q + 1(1-Q) = 2Q +10(1-Q)
The likelihood/ percentage of time/ probability
that X choose strategies X1, X2
is Q=9/11=0,82, (1-Q)=2/11=0,18 respectively.
The value of the game/ expected gains/
expected payoffs/ weighted average:
v= 4Q+1(1-Q)=38/11 = 3.45

For player Y Similarly, P=8/11=0,73, (1-P)=3/11=0,27 is the

optimal mixed strategy for player Y.
Set the expected gains equal, we
obtain:
The value of the game
4P + 2(1-P) = 1P +10(1-P) v= 4P+2(1-P)=38/11 = 3.45

Conclusion:
Since the value of the game is 3.45 (positive), Player X (player in
rows) has more advantages in this game.
 SUMMARY
PROCEDURE FOR TWO-PERSON ZERO-SUM GAME THEORY PROBLEMS
• Develop a payoff table for the problem (if
Step 1 required).

• If the size of the game is not 2x2, apply the

Step 2 dominance method to reduce the size of the
game to 2x2.

• Apply the pure strategy to find the saddle

Step 3 point;

• If no saddle point found, continuously apply

Step 4 the mixed strategy.

Step 5 • Draw a conclusion

In-class Practice 1
In-class Practice 2

• What is the likelihood

that the Player X will
choose the strategy X2?
• What is the value of the
game?
 In-class Practice 3
ACB Co. and SCG Co. are competitors in soft drink products market. They
consider investing some money in advertising campaigns. If ACB Co.
invests $30000 in advertising campaign, it will gain 5% market share if
SCG Co. does nothing, it will gain 3% market share if SCG Co. invests
$15000 in advertisement, and gain 2% market share if SCG Co. invests
$22000 in advertisement. If ACB Co. invests $25000 in advertising
campaign, it will gain 4% market share if SCG Co. does nothing, it will gain
1% market share if SCG Co. invests $15000 in advertisement, and loss 1%
market share if SCG Co. invests $22000 in advertisement. If ACB Co. does
nothing, it will not loss its market share if SCG Co. does nothing, it will loss
3% market share if SCG Co. invests $15000 in advertisement, and loss 4%
market share if SCG Co. invests $22000 in advertisement.

(a) Develop a payoff table for this problem.

(b) What are the best strategies for each company using?
(c) What is the value of the game? Which company has more advantages?
Group activity: Computer practice

Using QM for Windows or

Excel QM to solve the
problems above.
 SUMMARY
• The study of how optimal strategies are formulated in
Game theory conflict.

• Allows only two persons or two groups to be involved in

Two-person game the game.

• The sum of losses for one player must equal the sum of
Zero sum gains for the other player.

• Strategies for the players can be obtained without

Pure strategy game making any calculations.

When there is not a pure • Use other techniques such as mixed strategy, dominance,
strategy for both players and a computer solution for games larger than 2x2

• Dominance
• Minimax Criterion
• Mixed strategy game
Glossary • Pure strategy
• Saddle point game
• Two-person game
• Value of the game
• Zero-sum game
ASSIGNMENTS

Online Module 4 – Game theory

Submit in next class:

1. Assignments (Module 4): M4-9, M4-10, M4-12,
M4-15
2. One-page summary of the lecture.