LECTURE 7 – GAME THEORY

7.1 Definitions

 The term ‘game’ represents a conflict between two or more parties; Game Theory is really the
science of conflict.
 Situations in order to be termed as games must possess the following properties:
 The number of competitors is finite;
 There is a conflict of interest between the participants
 Each of the participant has available to him finite test of possible courses of action
 The rules governing these choices are specified and known to all players.
 The outcome of the game is affected by choices made by all of the players.
 The outcome for all specific sets of choices by all of the players is known in advance and
numerically defined.

7.2 Types of Games

Games can be of several types. Important ones are as follows:

7.2.1 Two-person games and n-person games

In two person games the players may have many possible choices open to them for each play of
the game but the number of players remains only two. In case of three players, it becomes three-
person game. In case of more than two persons, it is named n person game.

7.2.2 Zero sum and non-zero sum game

A zero sum game is one in which the sum of the payments to all the competitors is zero for every
possible outcome of the game. In other words, in such a game the sum of the points won equals
the sum of the points lost i.e. one players wins at the expense of the other (others). In a non-zero
sum game the sum of the payoffs from any play of the game may be either positive or negative
but not zero.

7.2.3 Game of perfect information and games of imperfect information.

Whatever strategy is adopted by either player, if the same can also be discovered by his
competitors, then such games are known as games of perfect information. In case of games of
imperfect information neither players knows the entire situation and must be guided in part by his
guess as to what the real situation is.

7.2.4 Games with finite moves and games of infinite number of moves.

Games with finite number of moves are those where the number of moves is limited to a fixed
magnitude before play begins, but if the game could continue over an extended period of time
and no limit is put on the number of moves then it is refereed as a game of unlimited number of
moves.

7.2.5 Constant-sum game.

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In some situation zero sum game is correctly referred to as constant-sum game. E.g. a
competitive struggle for share of the market by two firms (a duopoly). In such a case every
percentage point gained by one of the firms is necessarily lost by the other. This situation is
ordinarily called a two-person, zero-sum game. But strictly speaking this is a constant-sum rather
than a zero-sum game because the sum of the two market shares is the fixed number 100 (per
cent), not zero.

7.2.6 2x2 Two-person games and 2xm and mx2 games.

Two person zero-sum games with only two choices open to each player are denoted as 2x2. Two
person games but a game in which one of the players has more than two choices of rows or
columns and in which the other player has exactly two choices is referred to as mx2 or 2xm game
respectively.

7.2.7 3x3 and larger games.

Two-person zero-sum games can be of size 3x3 and larger. If each of the two players has 3
choices then the game is of 3x3 type and if the choices open to any of the player or to both
players are more than three, the game is referred to that of a larger size.

7.2.8 Games against nature

Expected utility theory for a single agent is sometimes called the theory of "games against
nature". Consider this example.

Example 1: Planning a party

Our agent is planning a party, and is worried about whether it will rain or not. The utilities and
probabilities for each state and action can be represented as follows:

Nature's states:
Rain No rain
(p=1/3) (p=2/3)
Party planner's possible Outside 1 3
actions: Inside 2 2

The expected utility of an action A given uncertainty about a state S = Probability(S|A)*Utility(S|A)

+ Probability(not S|A)Utility(not S|A) Note that action A can be viewed as a compound gamble or
outcome. Also, note that the probability of a state can depend on the agent's choice of action,
although, in the above example, it does not.
For the party problem: EU(Outside) = (1/3)(1)+(2/3)(3) = 2.67; EU(Inside) = (1/3)(2) + (2/3)(2) = 2

Therefore, choose Outside, the action with the higher expected utility

7.2.9 Negotiable (or corporative) and non-negotiable (or non-corporative) games.

In the examples below, we'll assume two self-utility maximizing agents (or players), each of whom
has complete information about the options available to themselves and the other player as well
as their own and the other's payoffs (utilities) under each option.
Example 2 - Friends hoping to see each other

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Consider two people, Chris and Kim. They both enjoy each other's company, but neither can
communicate with the other before deciding whether to stay at home (where they would not see
each other) or go to the beach this afternoon (where they could see each other). Each prefers
going to the beach to being at home, and prefers being with the other person rather than being
apart. This game can be represented by the following normal (or matrix) form:

Kim
Home Beach
Home (0,0) (0,1)
Chris
Beach (1,0) (2,2)

Each player has a set of strategies (={Home,Beach} for both players in this example). Specifying
one strategy i for the row player (Chris) and one strategy j for the column player (Kim) yields an
outcome, which is represented as a pair of payoffs (Rij,Cij), where Rij is the utility the row player
receives, and Cij is the utility the column player receives.

In this example, going to the beach is a (strictly) dominant strategy for each player, because it
always yields the best outcome, no matter what the other player does. Thus, if the players are
both maximizing their individual expected utilities, each will go to the beach. So Beach-Beach is
dominant strategy equilibrium for this game. Because of this, Kim and Chris, if they are rational,
do not need to cooperate (make an agreement) ahead of time. Each can just pursue their own
interest, and the best outcome will occur for both.

Example 3 - "Friends" with asymmetric preferences

Now consider Betty and John. John likes Betty, but Betty doesn't like John that much. Each
knows this, and neither wants to call the other before deciding what to do this afternoon: stay at
their respective homes or go to the neighborhood swimming pool. Here is the normal form:

John
Home Pool
Home (2,0) (2,1)
Betty
Pool (3,0) (1,2)

In this case, Betty's best strategy depends on what John does. But if she assumes John is
rational, she will reason that he will not stay home, because going to the pool is a dominant
strategy for him. Knowing this, she can decide to stay home (because 2>1). This is called
iterated dominance. In this example, Betty gets higher utility than John because of their relative
preferences, and John gets less utility than he would have if Betty wanted to be with him.
In this example, Pool-Home (3,0), Home-Pool (2,1), and Pool-Pool (1,2) are all Pareto optimal
outcomes. An outcome is Pareto optimal (or efficient) if no agent can be made better off than that
outcome without making another agent worse off. The equilibrium outcomes in both this
example and the previous one are Pareto optimal.

Example 4 - Prisoners' dilemma

Consider Stan and Leland, two prisoners who have each been offered a deal to turn state's
witness (defect) against the other. They can't communicate. They had originally agreed to
remain in solidarity, i.e. not testify against each other, but since the agreement cannot be
enforced, each must choose whether to honor it. If both remain in solidarity, then they will each
only be convicted of a minor chage. If only one defects, then the state will throw the book at the
other and let the defector go. If they both defect, each will get convicted of a serious charge. The
payoff matrix (higher positive utility implies a better outcome) is as follows:

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 Leland
Solidarity Defection
Solidarity (3,3) (1,4)
Stan
Defection (4,1) (1,1)

In this game, the strategy of defection is weakly dominant for each player, meaning that whatever
the other player does, defecting yields an outcome at least as good and possibly better than
remaining in solidarity would. Note that if the bottom right cell payoffs were (2,2) instead of (1,1),
then defecting would be strictly dominant for each player. Either way, Defection-Defection is
dominant strategy equilibrium. However, it is not Pareto optimal. Both players could be made
better off if neither defected against the other.

This is an example of a social dilemma: a situation in which each agent's autonomous

maximization of self-utility leads to an inefficient outcome. Such a situation can occur for any
number of people, not just two. An agreement by two people to trade with each other (involving
goods, services, and/or money) set's up a prisoners' dilemma-type game whenever the
agreement cannot be enforced.

Example 5 - Coordination

Let's go back to Chris and Kim. They are going to the same conference, and each is expecting
the other to be there, but they haven't seen each other yet. The conferees have their choice of
two activities on the first afternoon: swimming or hiking. They both hope to see each other -- if
they don't they will have no fun, and each prefers swimming over hiking. They must each decide
what to do before knowing where the other is going. Here is the normal form:

Kim
Swim Hike
Swim (2,2) (0,0)
Chris
Hike (0,0) (1,1)

The best outcome is obviously Swim-Swim, but going swimming is not dominant for either player.
Both Swim-Swim and Hike-Hike have the property that each player's strategy is the best (or tied
for the best) response to the other player's strategy in that pairing. This defines a more general
equilibrium notion called the Nash equilibrium. The dominance equilibrium of examples 1-3 are
all Nash equilibrium as well.

A third equilibrium exists in this game involving what are called mixed strategies. A mixed
strategy is a probability distribution over the pure strategies (which are Swim and Hike for each
player in this example). (Note that the players do not have to have the same set of strategies
available to them, even though that has been the case in all our examples.) In this example, if
each player individually throws a die and goes swimming if the die comes up 1 or 2, and goes
hiking if the die comes up 3, 4, 5, or 6, the resulting expected utility (2/3 for each player) cannot
be improved upon for either player given that the other player uses this strategy.

In 1950, John Nash (depicted somewhat fictitiously in the film A Beautiful Mind -- the book is
more accurate!) proved that every finite game, involving any number of players, has at least one
(Nash) equilibrium, though there might not be any that involve only pure strategies for all players.
In this example, there are three equilibria: the mixed strategy equilibrium (Swim,1/3; Hike,2/3)-
(Swim,1/3;Hike,2/3), and two pure strategy equilibria -- Swim-Swim and Hike-Hike.

When there is more than one equilibrium, and players cannot make binding agreements, they
must try to coordinate to arrive at an equilibrium outcome. When only one equilibrium exist, it is

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also Pareto optimal, as Swim-Swim is in this case, that fact should suggest to rational players that
it will be the one around which they coordinate. Many other criteria for equilibrium selection have
been studied (e.g. focal points, sub-game perfection, stability -- see the reading on game theory).

Example 6 - "Battle of the sexes"

Finally, let's consider Roy and Jen. They are going to the same conference as Kim and Chris in
example 5. They each would prefer to be in the same place (the swim or the hike), but their
preferences differ about which it should be. Roy would rather go swimming, and Jen would rather
go hiking. Here is the matrix form:

Jen
Swim Hike
Swim (3,2) (1,1)
Roy
Hike (1,1) (2,3)

This game has three Nash equilibria: Swim-Swim, Hike-Hike, and (Swim,2/3;Hike,1/3)-
(Swim,1/3;Hike,2/3). Note that the mixed strategies differ for each player in the third equilibrium:
each goes to their preferred activity with 2/3 probability.

All of the equilibria are Pareto optimal this time, so that does not help for selection. Only the
mixed strategy equilibrium results in equal expected utilities for the two players, so if both value
equality or symmetry, this might be the focal point. But of course it will be difficult for Roy and Jen
to see that unless they have studied game theory!

7.3 Value of a Game

Value of a game refers to the average payoff per play of the game over an extended period of
time. The saddle point in a payoff matrix is one which is the smallest value in its row and the
largest value in its column. The saddle point is also known as equilibrium point in the theory of
games. A payoff matrix that has a saddle point is equivalent to the value of the game.

Example 7

Solution

The value of the game is -1

Example 8
Y

Find the value of the game and strategies by each player.

Solution

Difference Inter-change Ratio

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 1 4 3 2 2/5
5 3 2 3 3/5
Difference 4 1
Inter-change 1 4
Ratio 1/5 4/5

V = (1*1/5) + (4*4/5) = 17/5

V = (5*1/5) + (3*4/5) = 17/5

V = (1*2/5) + (5*3/5) = 17/5

V = (4*2/5) + (3*3/5) = 17/5

Player X should play his first row 2/5 of the time and his second row 3/5 of the time. Similarly, Y
should play 1/5 of his time on first column and 4/5 of the time on second column.

7.4 Rule for Dominance

a. If all the elements in a column are greater than or equal to the corresponding elements in
another column, then that column is dominated.
b. Similarly, if all the elements in a row are less than or equal to the corresponding elements in
another row, then that row is dominated.

Dominated rows or columns may be deleted which reduces the size of the game. Always look for
dominance when solving a game.

Example 9

Determine the optimum strategies and the value of the game from the following 2xm payoff matrix
game for X:

Solution

Difference Inter-change Ratio

-1 -3 2 3 3/5
-4 -1 3 2 2/5
Difference 3 2
Inter-change 2 3
Ratio 2/5 3/5

V = (-1*3/5) + (-4*2/5) = -11/5

Graphical Method: The values can be plotted, the intersection denotes the value of the game and
can be directly read from the graph.

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 8

0
1 2

-2

-4

-6

Example 10

Determine the optimum strategies and the value of the game from the following payoff matrix
concerning a 2 person 4x2 game:
Y

Solution
There is no saddle point in the given game. This game also cannot be reduced by dominance.
However, six sub-games can be derived.

The value of the game is the highest value -3.57

Graphical Method:

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 4

0
1 2

-2

-4

-6

-8

-10

The optimal point is the lowest point which bound the figure from the top (marked as M)

Example 11

Determine the optimum strategies and the value of the game for the following payoff matrix
concerning a 3x3 game:
Y

Solution

If X adopts strategy X1, Y’s expectation is

1Y1 + 2Y2 – 1Y3 ≤ V

-2Y1 + 1Y2 + 1Y3 ≤ V
2Y1 + 0Y2 + 1Y3 ≤ V

where V is the value of the game. If we take Y = Y/ V

We have

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Maximize Y1 + Y2 + Y3
Subject to:
1Y1 + 2Y2 + 1Y3 ≤ 1
-2Y1 + 1Y2 + 1Y3 ≤ 1
2Y1 + 0Y2 + 1Y3 ≤ 1
Y1  0, Y2  0, Y3  0.

Solving the above using the simples method; yields

Y1 = .18 ; Y2 = 0.73; Y3 = 0.64 and X1 = .27 ; X2 = 0.45; X3 = 0.82

Objective = 1.55 (Therefore, 1/V = 1.55  V = 0.645)

Therefore (since Y = Y * V);

Optimum strategies for Y

Y1 = 0.116; Y2 = 0.471 and Y3 = 0.412

In a similar fashion, the Xs values are obtained as: X1 = 0.176; X2 = 0.294 and X3 = 0.529
7.5 Limitations of the Theory of Games

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 Businessmen do not have all knowledge required by the theory of games. They are not aware
of alternative strategies for themselves, let alone for the competitors.
 There is a great deal of uncertainty that cannot conveniently be inserted into game-theory
models. The outcome of the game may not be known with certainty in many cases.
 The minimax strategy implies that the businessman minimizes the chance of the maximum
loss. It is thus a very conservative rule.
 The techniques of solving games involving mixed strategies particularly in case of a larger
pay-off matrix is very complicated and this lessens significance of this sort of analysis.
 Though the game theory points out some of the important aspects of competitive situations
but still it is not a model that offers a complete solution particularly when the game does not
happen to be a strictly adversary game.

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