Game Theory for Managers

Topic: Introduction

Class: PGPM-TERM V
Course Objectives:

By the end of this course, students should be able to:

• decision-making in strategic situations, particularly in Business and Economic

Development.
• card games, wars, and various sports to strategic price fixing, negotiation, and group
cooperation.
• Students will be able to learn interpersonal and team skills to solve various management
problems with ethical reasoning.
Pre-requisite for the course
The knowledge and application of Managerial Economics is the pre-requisite for this
course.
Course material:
Recommended Text Books
 Alka Chadha, Game Theory for Managers: Doing Business in a Strategic World, PHI
Learning, Eastern Economy Edition, 2021.
 Dixit, A., & Nalebuff, B. J., The Art of Strategy: A Game Theorist’s Guide to Success in
Business and Life, W.W Norton & Company, 2008.

Additional Suggested text

 William Spaniel, Game Theory 101: The Complete Textbook, CreateSpace Independent Publishing Platform, 2011.
 Avinash Dixit, Susan Skeath and David H. Reiley, Jr., Games of Strategy, Viva-Nortan Student Edition, Third Edition,
2017.
 Evaluation scheme:

Class participation Individual 10% Attendance is a must for obtaining full marks,
participation in games played in class and
contributing to discussions in class.
Quizzes Individual 20% Close-book, Multiple-choice questions, simple
calculators allowed

Assignment & Individual / 20% Case submission and presentation on analyzing a

Presentation Group real life or hypothetical situation using the tools
of game theory
Mid-term exam Individual 20% Close-book, simple calculators allowed.
End-term exam Individual 30% Close-book, simple calculators allowed.
 SESSION-WISE COURSE OUTLINE:

Session Number Topics to be covered Chapter

1 Introduction: Elements of a game, Strategic thinking Ch 1
2 Simultaneous-move game: Prisoner’s Dilemma, Dominant Strategies Ch 2
Case Study (OPEC, Covid-19 and Oil Crash)
3, 4 Coordination games: Median voter theorem, minimax, battle of the sexes Ch 3
5, 6 Mixed strategies: Randomized strategies, random checks Ch 4
Case Study (Champions League)
7 Sequential-move game: Backward induction, first-mover advantage Ch 5
Case Study (Toyota Prius: The Predecessor)
8 Oligopoly models: Cournot model, Stackelberg model Ch 6
QUIZ 1
9 Oligopoly models: Bertrand model Ch 6
Case Study (Free Generics for all Indians)
10, 11 Repeated games: finite repetitions, infinite repetitions, strategic move Ch 7
Case Study
12 Asymmetric information: Moral hazard, market for lemons, adverse selection Ch 8

13 Auctions: Auction environment, common-value auctions, winner’s curse Ch 9

Case Study (IPL Auctions)

14 Bayesian games: Bayesian updating, signaling, screening Ch 10

Case Study (The Case for Case Competitions)

15, 16 Coalition Games: Collective action games, Tragedy of the commons, externalities Ch 11

17 Bargaining and contracts: Surplus value, negotiations, ultimatum game Ch 12

Case Studies (EU and Brexit)

18 Course review and practice problems

QUIZ 2

19 Presentations

20 Presentations
Game Theory:
A Short History
 The origin of formal game theory can be traced back to a 1928
paper by John von Neumann, which was elaborated into a classic
book Theory of Games and Economic Behaviour in 1944 by John
von Neumann and Oskar Morgenstern.
 However, it was John Nash, the 1994 Noble Prize winner for
Economics, who developed game theory into a general framework
of strategic interactions concerning competition and cooperation.
What is a game?
• A game is being played whenever people interact with
each other
• Interdependence
• One person’s behavior affect another’s well-being
• What is not a game?
• N=1: monopoly
• N= infinity: perfect competition

Game Theory is the study of rational decision-making in strategic interactions.

Firms competing for market share, war and diplomacy in international affairs,
opponents in election, bidding in aution, fishing in international waters, personal
relationships.
 ● game Situation in which players (participants) make strategic decisions that take into account
each other’s actions and responses.
● payoff Value associated with a possible outcome.

● strategy Rule or plan of action for playing a game.

● optimal strategy Strategy that maximizes a player’s expected payoff.
Player 2

Strategy A B C
a 12,11 11,12 14,13
Player 1

b 11,10 10,11 12,12

c 10,15 10,13 13,14
 coin nim game

It is a game played by two players. It consists of 6 coins in 3 rows. Each player alternately
takes (the German word ‘nimm’ means ‘take’) a certain number of coins and the player who
takes the last one wins the game. In one move, each player can remove any number of coins,
but only from one row. So, these are the rules of the game. The strategies available are (i)
take a coin from row 1 (ii) take any number of coins from row 2 or (iii) take any number of
coins from row 3. A player’s actions depend on the other player’s actions and the game ends
when one player is left to pick the last coins and wins the game.
 Types of Games

1. Cooperation: where all can become better off without hurting anyone. India (rice)-
Japan (processor chips). Non-cooperative game- Gambling
2. Timing: Simultaneous-move games or sequential-move games
For instance, R&D races to launch a new product like the smartwatch between Apple and
Samsung is a case of a simultaneous-move game.
When Apple comes out with an iPhone that makes it so different from the cell phone that
it is dubbed as a new product altogether called a smartphone, it is a first-mover.
3. Certainty: Games of certainty or pure strategy- Mixed strategy
 4. Repetition: one-shot game or repeated game. Split or Steal game
For instance, consider the British game show, the Golden Balls, where to win the
prize money, the two players have to pick a ball with ‘Split’ written on it or ‘Steal’
written on it. If both pick ‘Split’, the prize money is shared, if both pick ‘Steal’,
nobody gets anything, and in case one picks ‘Steal’ and the other picks ‘Split’, the
former gets the entire prize money.

5. Information:
Games of symmetric information – Buying a good on auction sites such as eBay. Game
of asymmetric information-bidding for oil exploration rights.
GAME THEORY IN ACTION

1.Conflict

2.War

3.Films: The Imitation Game

4. Negotiations
Brexit was the withdrawal of the United
Kingdom from the European Union at 23:00
GMT on 31 January 2020. The UK is the first
and only sovereign country to have left the EU.
The UK had been a member state of the EU and
its predecessor the European Communities
since 1 January 1973.
5. Mythology: Mahabharata

6. Politics:

Are ‘freebies’ bad and a waste of money?

AIADMK – DMK
Let us play a game of cards. Assume that you are in a casino and the dealer has
devised the following card game. There are two piles of red and black cards. You are
asked to pick a red or black card from these packs from your table. The casino dealer
will randomly pair your response with a person sitting at another table in the casino.
Neither you nor your pair will ever know with whom you are paired. The winnings
from the game are distributed according to the following rules:
 If you pick red and your pair picks black, then you will get Rs. 2000 and your pair
loses Rs.1000
 If both pick red, then you both get nothing.
 If you pick black and your pair picks red, then you will lose Rs.1000 and your pair
gets Rs. 2000.
 If both pick black, then you both will get Rs.1000 each.
SIMULTANEOUS – MOVE GAMES
Simultaneous-move games are static games where players simultaneously decide
upon their strategies from a set of available strategies.
A game of discrete strategy involves a player deciding between one or the other of
the available strategies. For instance, a firm producing mineral water deciding to
charge a price of `10 or `15 for a bottle is a game of discrete strategies, where the firm
has to choose between one of the two price levels.
A game of continuous strategies involves a player choosing among a continuum of
strategies. For instance, if the same firm producing mineral water has to decide upon a
price in the range of `10 to `15 per bottle, it is a game of continuous strategies, where
the firm has to choose any price from the given price range.
Competition Versus Collusion: The Prisoners’ Dilemma
● prisoners’ dilemma Game theory example in which two prisoners must
decide separately whether to confess to a crime; if a prisoner confesses, he will
receive a lighter sentence and his accomplice will receive a heavier one, but if
neither confesses, sentences will be lighter than if both confess.

PAYOFF MATRIX FOR PRISONERS’ DILEMMA

PRISONER B
CONFESS DON’T CONFESS

Confess –5, –5 –1, –10

Prisoner A –10, –1 –2, –2
Don’t confess
 An Oligopoly Game

Iraq’s Decision

High Production Low Production

Iraq gets $40 billion Iraq gets $30 billion

High
Production

Iran gets $40 billion Iran gets $60 billion

Iran’s
Decision Iraq gets $60 billion Iraq gets $50 billion

Low
Production

Iran gets $30 billion Iran gets $50 billion

Copyright©2003 Southwestern/Thomson Learning

 Dominant Strategies
● dominant strategy Strategy that is optimal no matter what an opponent does.

TABLE 13.1 PAYOFF MATRIX FOR ADVERTISING GAME

Firm B
Advertise Don’t advertise

Advertise 10, 5 15, 0

Firm A
Don’t advertise 6, 8 10, 2

Advertising is a dominant strategy for Firm A.

The same is true for Firm B: No matter what firm A does, Firm B does best by advertising.
The outcome for this game is that both firms will advertise.
● equilibrium in dominant strategies Outcome of a game in which each
firm is doing the best it can regardless of what its competitors are doing.
What value needs to be placed in ‘A’ for Player 1 to have a dominant strategy?

Player 2

Advertise Don’t advertise

Advertise 3,4 0, 5
Player 1
Don’t A, 0 1, 1
advertise
Let us play a game of cards. Assume that you are in a casino and the dealer has
devised the following card game. There are two piles of red and black cards. You are
asked to pick a red or black card from these packs from your table. The casino dealer
will randomly pair your response with a person sitting at another table in the casino.
Neither you nor your pair will ever know with whom you are paired. The winnings
from the game are distributed according to the following rules:
 If you pick red and your pair picks black, then you will get Rs. 2000 and your pair
loses Rs.1000
 If both pick red, then you both get nothing.
 If you pick black and your pair picks red, then you will lose Rs.1000 and your pair
gets Rs. 2000.
 If both pick black, then you both will get Rs.1000 each.
 CARD GAME

Pair
Red Black

Red 0, 0 2, -1
You
Black -1, 2 1, 1

The game highlights the dilemma that players face, where both the
players do what is best for them, but end up with a bad outcome.
Competition Versus Collusion: The Prisoners’ Dilemma
● prisoners’ dilemma Game theory example in which two prisoners
must decide separately whether to confess to a crime; if a prisoner
confesses, he will receive a lighter sentence and his accomplice will
receive a heavier one, but if neither confesses, sentences will be lighter
than if both confess.

PAYOFF MATRIX FOR PRISONERS’ DILEMMA

PRISONER B

CONFESS DON’T CONFESS

Confess –5, –5 –1, –10

Prisoner A
Don’t confess –10, –1 –2, –2
Prisoner’s Dilemma
You are working with a friend on a joint project. Each of you can
either work hard or goof off.
Person 2

Work Hard Goof off

Work Hard 2, 2 0, 3
Person 1
Goof off 3, 0 1, 1

Working on a Joint Project

TABLE Weakly Dominant Strategies

Firm 2
Low High

Low 50, 50 10, 70

Firm 1
High 70, 10 10, 10
Unfortunately, not every game has a dominant strategy for each player.

TABLE MODIFIED ADVERTISING GAME

Firm B
Advertise Don’t advertise

Advertise 10, 5 10, 10

Firm A
Don’t advertise 6, 8 20, 2

Now Firm A has no dominant strategy. Its optimal decision depends on what
Firm B does. If Firm B advertises, Firm A does best by advertising; but if Firm B
does not advertise, Firm A also does best by not advertising.
One Application of the prisoner’s dilemma is found in the working of a cartel.
 OPEC (Organisation of Petrol Exporting Countries)
 Cartel is likely to work well when the demand for its product is inelastic and its
market share is high visa-vis non-member producers.
Venezuela
Maintain Exceed
Maintain 5, 5 3, 7
Iran
Exceed 7, 2 3, 3

The dominant strategy of both the countries is to exceed their production quotas, which will result in the Nash
equilibrium {Exceed Exceed}. However, in this game, the strategy to produce more than the quota is a weakly
dominant strategy for Iran, while to produce more than the quota is a strictly dominant strategy for Venezuela.
Thus, cartel dilemma occurs when the members have to decide whether to follow the production quota set for them
or cheat so as to exceed the quota to earn higher revenues. For each member, it is dominant strategy to exceed the
quota and if each member plays her dominant strategy, the outcome is the total output far in excess of the monopoly
output and resultant lower prices for everyone.
 CASE STUDY 2.1
OPEC, COVID-19 AND OIL CRASH
In March 2020, as the world grappled with the COVID-19 pandemic, there was another
crisis gripping oil markets and the effectiveness of OPEC as a cartel that influences prices.
The price of Brent crude oil crashed from $65 per barrel at the start of the year to $34 per
barrel. In April 2020, the price of U.S. crude oil breached the negative territory, reporting a
price of –$37 per barrel. As the COVID-19 contagion spread across countries and
lockdowns were imposed, global demand for oil fell by 30 million barrels a day. For the first
time in history, the cost of production, transportation and storage exceeded the
benchmark price, effectively paying people to offload the piled-up barrels. The OPEC+
informal grouping of OPEC and non-OPEC countries exporting oil including Russia, had
propped up prices since December 2018 by cutting back production. However, this
agreement fell apart in March 2020 as Saudi Arabia and Russia abruptly ended the
production cuts with an eye on garnering greater market share. At a time when the corona
virus destroyed one-third of global oil demand, a fall greater than the total production of
the OPEC, oil prices crashed. While Saudi Arabia miscalculated the extent of the fall in
demand, Russia misjudged the Saudi response of flooding the market. Riyadh acted
aggressively by cutting export prices, producing at full capacity and offering discounts to
refineries using Russian crude oil.
In the April meeting of OPEC+, it was decided to cut production by 9.7 million barrels per day
over May and June and by 7.7 million barrels per day in July. Saudi Arabia ended its price war
with Russia. The U.S. shale companies shut down unprofitable wells. Demand recovered as
lockdowns ended. By May 2020, oil prices had started their upward trajectory, even though
cartel members had failed to comply with quota requirements. OPEC compliance was reported
at 77 per cent, with Iraq and Nigeria reporting a compliance rate of 42 per cent and 33 per
cent, respectively. However, as teleporting via the Internet became the new normal for
interactions with a fall in travel demand, the oil industry including OPEC, was likely to face
major reconfigurations. If more countries would join the OPEC+ grouping and agree to joint
production cuts, OPEC as the most powerful player in the oil market could remain relevant,
otherwise the U.S. had already become the world’s largest producer of crude riding on the
back of shale gas. According to a report by the King Abdullah Petroleum Studies and Research
Centre, “The magnitude of the current disruption is far beyond what OPEC can deal with
alone,” and would require greater international cooperation.
 Strictly Dominant Strategy is to confess, while the strictly dominated strategy
is not to confess.
 A strictly dominant strategy is the one that is optimal for a player that yields
higher payoffs, irrespective of what the rival does.
 A strictly dominated strategy is the one where payoffs from such a strategy
are strictly lesser than that from any other strategy, no matter what the
other player does.
 For a rational player, the way to play any game is to play the dominant
strategy because it gives better outcome for every strategy.
 The result where rational choices lead to outcomes that make the players
worse off is called a social dilemma.
 Communication is not a solution to the Prisoner’s Dilemma.
Iterated Elimination of Dominated Strategies

Another way to solve a game is to eliminate the dominated strategies

repeatedly till you are left with the equilibrium outcome.

Flipkart

High Low

High 10, 10 1, 20
Amazon

Low 20, 1 5, 5
 Iterated Elimination of Dominated Strategies
Player 2

Left Center Right

Up 13, 3 1, 4 7, 3
Player 1

Middle 4, 1 3, 3 6, 2

Down -1, 9 2, 8 8, -1
The Battle of the Bismarck Sea was a battle fought in February 1943 in Southeast Asia during World War II,
between the Japanese Navy and the US Air Force. In game theory, its modeling was done by O. G.
Haywood, Jr. in his article “Military Decision and Game Theory”, 1954. It’s a game used in game theory to
analyze zero-sum games with two players.
A good example of elimination of dominated strategy is the analysis of the Battle
of the Bismarck Sea. In this game, as depicted in the adjacent game matrix,
Kenney has no dominant strategy (the sum of the payoffs of the first strategy
equals the sum of the second strategy), but the Japanese do have a weakly
dominating strategy, which is to go North (the payoffs are equal for one strategy
but strictly better for the other). Since only one of them has a dominant strategy,
there is no dominant strategy equilibrium. We must then proceed by eliminating
dominated strategies. As we’ve already mentioned, for the Japanese strategy ‘go
North’ weakly dominates strategy ‘go South’. Therefore, we eliminate the
strategy ‘go South’ for the Japanese, who will go North. Now that we only
consider the Japanese going North, Kenney’s strategy ‘go North’ is strictly
dominant over strategy ‘go South’, which will be eliminated. Therefore, North-
North is the weak-dominance equilibrium.
However, as it was mentioned before, it can be easily seen that the game has lost
its strategic nature.
Ex: Two major networks are competing for viewer ratings in the 8:00-9:00 P.M. and 9:00-10:00 P.M. slots on a given
weeknight. Each has two shows to fill this time period and is juggling its lineup. Each can choose to put its “bigger” show
first or to place it second in the 9:00- 10:00 P.M. slot. The combination of decisions leads to the following “ratings points”
results:
MOVIE: A BEAUTIFUL MIND
 The Nash Equilibrium

Dominant Strategies: I’m doing the best I can no matter what you do.
You’re doing the best you can no matter what I do.
Nash Equilibrium: I’m doing the best I can given what you are doing.
You’re doing the best you can given what I am doing.

THE PRODUCT CHOICE PROBLEM

Two new variations of cereal can be successfully introduced—provided that
each variation is introduced by only one firm.
TABLE PRODUCT CHOICE PROBLEM
Firm 2
Crispy Sweet
Crispy –5, –5 10, 10
Firm 1
Sweet 10, 10 –5, –5

It must be noted that any dominant strategy equilibrium is always a Nash equilibrium.
However, not all Nash equilibria are dominant strategy equilibria.
TABLE Investment Game

Ford
Maintain Expand

4, 3 2, 4
Maintain
GM
Expand 2, 4 3, 5
Ex: Two firms are in the chocolate market. Each can choose to go for the high end of the market (high quality) or
the low end (low quality). Resulting profits are given by the following payoff matrix:

What outcomes, if any, are Nash equilibria?

Ans: A Nash equilibrium exists when neither party has an incentive to alter its strategy, taking the other’s strategy as
given. If Firm 2 chooses Low and Firm 1 chooses High, neither will have an incentive to change (100 > -20 for Firm 1
and 800 > 50 for Firm 2). If Firm 2 chooses High and Firm 1 chooses Low, neither will have an incentive to change
(900 > 50 for Firm 1 and 600 > -30 for Firm 2). Both outcomes are Nash equilibria. Both firms choosing low is not a
Nash equilibrium because, for example, if Firm 1 chooses low then firm 2 is better off by switching to high since 600
is greater than -30.