Game Theory

Many business/practical problems require decision making in a competitive

situation where there are two or more opposing parties with different/conflicting
interests.
For example: Candidates for an election,
Advertising and marketing campaigns by competing business firms.

A competitive situation will be called a Game. If it has the following properties:

1) There are a finite no. of competitors (participants) called players.
2) Each player has a finite number of strategies (alternatives) available to him.
3) A play of the game takes place when each player employs his strategies.
4) Every game results in an outcome, e.g., loss or gain, usually called payoff to
some players.
Payoff matrix:
A finite or infinite number of possible courses of action available to a player are
called strategies.
A game can be designated as being a one-person, two-person, or n-person (with n
greater than two) game, games in each category having their own distinctive
features.
One-person games
Two-person games:
When there are two competitors playing a game, it is called a two-person game. In case the no.
of competitors exceeds two, say n then the game is said to be n person game.,
Two Person Zero Sum Game
In a game of two persons, if the algebraic sum of the gains and loss of both the players after the
game is zero, then it is called 2-person-zero-sum game.
Assumptions
1. There are 2 players having conflicting interests.
2. Each player has a finite number of strategies.
3. Each strategy selected by a player results into a certain pay-off and algebraic sum of these
pay-offs to both players is zero.
Saddle point of a Game
Maximin = Minimax

• Two-person-zero-sum game with saddle point are called pure strategy

games and two-person zero-sum game without saddle point are called
mixed strategy games.
Pay-off Matrix
For instance, consider the following pay-off matrix: The gains resulting from a game is
presented in the form of a table called “ pay-off matrix”. A pay-off matrix comprises n
rows and m columns. Where n and m indicate the number of strategies of first player and
second player, respectively. The pay-offs of each combination of the strategies of players
are placed as elements of matrix. A positive element shows the gain to the first player (i.e.,
payment from II to I) and negative entry indicates the loss to the I player (i.e., payment
from I to II).
Player B
B1 B2 B3 B4 B5
A1 4 8 -2 6 4

Player A A2 3 6 5 3 2
A3 2 -9 1 7 10

If the player chooses the first strategy and the II player uses second strategy, then the I
player gains 8 units and the II player pays 8 units and similarly, if the 1 player chooses the
third strategy and second player uses II strategy, then the 1 player loses 9 units and pays it
to the II player and II player gains 9 units.
Strategies are classified into two types, namely, Pure strategy and Mixed Strategy.
1. A pure Strategy is a decision of the player to always select the same strategy.
A two-person zero sum game with pure strategy
1. A Mixed Strategy is a decision of the player to select more than one strategy with fixed
probabilities. A mixed strategy is advantageous since the opponent is always kept guessing.
Value of the Game
The value of the game is the “expected gain to a player” if he and his opponent use their best
strategies.
Saddle Point
Maximin = Minimax
A saddle point in a pay-off matrix corresponds to that element of the matrix which represents the
‘Maximin’ value of a player and Minimax value of his opponent.
A saddle point is a payoff that is simultaneously a row minimum and a column maximum of a
payoff matrix. To locate saddle points, circle the row minima and box the column maxima. The
saddle points are those entries that are both circled and boxed.
 Step to solve game:
Step 1. Find the saddle point, if the game has saddle point the game is solved. Write the
optimal strategy and the value of the game.
Step 2. If no saddle point, try to reduce the size of the matrix given (m × n) to:
(a) 2 × 2 matrix, which has formula for optimal strategies and the value of the game. Use
the formula to get the answer.
(b) 3 × 2 or 2 × 3 matrix and use Sub game method to get the answer. (The sub games are
once again 2 × 2 games).
(c) To m × 2 or 2 × n matrix and use graphical method to get solution. Graphical solution
will give us way to 2 × 2 matrix.
Step 3. Use algebraic method to get the solution.
Step 4. Use Linear-programming approach to get the solution. Use simplex method to get
solution (Duality principle in Linear Programming is used).
Step 5. Use Iteration method or approximate method to get the solution. All these
methods are explained by using numerical examples in the following discussion.
Problem: The matrix given below illustrates a game, where competitors A and B are
assumed to be equal in ability and intelligence. A has a choice of strategy 1 or
strategy 2, while B can select strategy 1 or strategy 2. Find the value of the game.

B’s strategy
B1 B2
A1 4 6
A’s strategy
A2 3 5
Solution:

Check: Saddle point of the game: Maximin = Minimax

Maximin = Max (Row Min) = 4
Mini (Column max) = 4
The element is the row minimum and column maximum. Hence the
element
is the saddle point and the value of the game = 4.
Problem: In a certain game player has three possible courses of action L, M and N,
while B has two possible choices P and Q. Payments to be made according to the
choice made.
Choices Payments
L,P A pays B Rs.3
L,Q B pays A Rs. 3
M,P A pays B Rs.2
M,Q B pays A Rs.4
N,P B pays A Rs.2
N,Q B pays A Rs.3

What are the best strategies for players A and B in this game? What is the value of
the game for A and B?
Solution: The pay of matrix for the given problem is:
B’s strategy Row Min.
P Q
L -3 3 -3
A’s strategy M -2 4 -2
N 2 3 2
Col Max. 2 4

Optimal strategies for A and B in terms of probabilities are A (0, 0, 1) and B (1, 0)
and the value of the game is v = +2
Example: Let A and B be any 2 firms in an area have been selling a product competing for a larger
share of the market. Let us assume that these firms are considering the same three strategies in a bid to
gain the share in the market: Low advertising, high advertising and quality improvement and let these
firms can employ only one of the strategies at a time. Under these conditions, there are 3 x 3
combinations of the moves possible and the corresponding pay-off is given below. The strategies of
low advertising, high advertising and quality improvement is marked as a1, a2 and a3 for the firm A
and b1, b2 and b3 for the firm B.
B’s strategy Row Min.
b1 b2 b3
a1 12 -8 -2 -8
A’s strategy a2 6 7 3 3
a3 -10 -6 2 -10
Col Max. 12 7 3

Maximin = Maximum of Row Minimum =3

Minimax = Minimum of Column Maximum = 3
Therefore, Saddle point = 3
Value of the game =3
Problem: Solve the following two person zero sum game with the following payoff
matrix of player A and value of the game

B’s strategy

P Q

L 9 2
A’s strategy
M 8 6

N 6 4
Optimum strategy for A is A2 and for B is B2
Problem: Solve the following two person zero sum game with the following payoff
matrix of player A and find the value of the game. Also find the optimum strategy
for A and B.

Player B
B1 B2 B3 B4
Player A A1 -5 2 0 7
A2 5 6 4 8
A3 4 0 2 -3
Game theory with mixed strategy
Consider the following matrix with respect to player A and solve it optimally.

Row
Player B minimum
I II
I 9 7 7
Player A II 5 11 5
Coll. Max 9 11
Maximin =7 ,Minimax = 9,
The game has no saddle point.
In order to proceed with mixed strategy

Player B
I II Oddments Prob.
I 9 7 11-5 =6 6/8 = 3/4
Value of the = (9*6+5*2)
Player A II 5 11 9-7=2 2/8 = 1/4 game /(6+2)
oddments 11-7 = 4 9-5 = 4
Probability 4/8 = 1 /2 4/8 = 1/2 =(54+10)/8 = 8
If no saddle point, To determine the optimal strategies, the analyst needs to evaluate
the probabilities (the proportion of time for which each strategy is played). For
doing so we have 3 methods namely:

1. Principle of dominance

2. Algebraic Method

3. Linear Programming Method.

4. Iterative Method for Approximate Solution

In case there is no saddle point then principle of dominance is used. The given game matrix (m ×
n) may be reduced to m × 2 or 2 × n or 2 × 2 matrix, which will help us to proceed further to solve
the game.

1. If all the elements of a column (say ith column) are greater than or equal to the corresponding
elements of any other column (say jth column), then ith column is dominated by jth column.

2. If all the elements of rth row are less than or equal to the corresponding elements of any other
row, say sth row, then rth row is dominated by sth row.

3. A pure strategy of a player may also be dominated if it is inferior to some convex

combinations of two or more pure strategies, as a particular case, inferior to the averages of
two or more pure strategies.
 Example: Solve the game whose payoff matrix is:

B’s strategy
I II III
I 1 7 2
A’s strategy II 6 2 7
III 5 1 6

Check whether the saddle point of the game exist or not?

 No saddle point. Hence reduce the matrix by method of dominance.
B’s strategy Row Min.
I II III
I 1 7 2 1
A’s strategy II 6 2 7 2
III 5 1 6 1
Col Max. 6 7 7

B’s third strategy gives him 2,7,6 units of money when A plays his I, II, and III
strategies. When we compare this with the B's first strategy, it clearly shows that the
payoffs of first strategy are superior or better to that of third strategy. Hence B’s
third strategy is dominated by the B’s first strategy. Hence we remove the third of B
strategy from the game. The reduced matrix is
 The reduced matrix is:

B’s strategy Row Min.

I II
I 1 7 1
A’s strategy II 6 2 2
III 5 1 1
Col Max. 6 7

No Saddle point. Reduce the matrix by method of dominance. Consider A’s II

strategy. The payoffs are 6 and 2 units of money when B plays his II and III strategy.
When we compare this with A’s III strategy, which fetches only 5 and 1 units of
money, which is inferior to payoffs of II strategy. Hence, we can remove A's third
strategy form the game.
The reduced matrix is:

B’s strategy Row Min.

I II
I 1 7 1
A’s strategy II 6 2 2
Col Max. 6 7

No saddle point. Hence apply the formula.

Let x and 1–x be the probability of A playing I, and II and y and 1 – y be the
probability of B playing I and II respectively.
We have
Value of the game

Solution to the game is: A (0.4, 0.6, 0) and B (0.5, 0.5,0) and value of
the game is v = 4 i.e. A always win 4 units of money.
Formula to calculate value of the game :
Let A and B be any two players with the following pay-off matrix; , and ,
denote the strategies of A and B respectively. Let denote the elements of pay-off
matrix i, j = 1,2
B’s strategy
𝑏 𝑏
𝑎 𝑃 𝑃
A’s strategy 𝑎 𝑃 𝑃

Player A has only 2 strategies namely, a1 and a2. If probability that he chooses a1 is x
then probability that he chooses a2 is 1 – x. Similarly, if probability that player B chooses
b1 and b2 is y and 1 – y respectively. Let us consider the expected gain which is the
weighted average of the possible outcomes and is the product of payoff and the
probabilities of the strategies.
If player B plays throughout, then the gain to A is equal to

If player B plays throughout, then the gain to A is equal to

From (1) and (2)

Therefore,
A similar argument holds good for B whose best strategy is

The value of the game i.e., gain to A from B can be obtained by substituting for x in
(1) which on substitution and rearrangement becomes