GAME Theory

Prepared by: Name: Mohammed Asif Khan S. Pathan Roll No.: 2011011 PG-13, IWSB

Submitted to: Prof. Veeresh Sharma

Game theory
Introduction 1
Game theory is the formal study of decision-making where several players must make choices that potentially affect the interests of the other players. Or, it is the formal study of conflict and cooperation. Its concepts apply whenever the actions of several agents are interdependent. These agents may be individuals, groups, firms, or any combination of these. The concepts of game theory provide a language to formulate structure, analyze, and understand strategic scenarios. As a mathematical tool for the decision-maker, the strength of game theory is the methodology it provides, for structuring and analyzing problems of strategic choice. Game theory consequently is relevant to ethics too, and it is used in moral and political philosophy in a variety of ways.

History 1
The earliest example of a formal game-theoretic analysis is the study of a duopoly by Antoine Cournot in 1838. The mathematician Emile Borel suggested a formal theory of games in 1921, which was furthered by the mathematician John von Neumann in 1928 in a theory of parlor games. Game theory was established as a field in its own right after the 1944 publication of the monumental volume Theory of Games and Economic Behavior by von Neumann and the economist Oskar Morgenstern. In 1950, John Nash demonstrated that finite games have always have an equilibrium point, at which all players choose actions which are best for them given their opponents choices. This central concept of non-cooperative game theory has been a focal point of analysis since then. In the 1950s and 1960s, game theory was broadened theoretically and applied to problems of war and politics. Since the 1970s, it has driven a revolution in economic theory. Additionally, it has found applications in sociology and psychology, and established links with evolution and biology. Game theory received special attention in 1994 with the awarding of the Nobel Prize in economics to Nash, John Harsanyi, and Reinhard Selten. At the end of the 1990s, a high-profile application of game theory has been the design of auctions. Prominent game theorists have been involved in the design of auctions for allocating rights to the use of bands of the electromagnetic spectrum to the mobile telecommunications industry.
1. Game Theory, CDAM Research Report LSE-CDAM-2001-09, By Theodore L. Turocy, Texas A&M University and Bernhard von Stengel, London School of Economics.

Various theories
Adam Smith Vs. John Nash
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Adam Smith proposed that everybody should work to his/her best level and for his/her own betterment and in this manner the whole community becomes better. According to his theory of economics, "The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state. But John Nash questioned the theory by Smith, by arguing that the mutual growth is the optimal solution. He gave Nash equilibrium based on this. That stated that: Nash equilibrium is a situation where each player chooses his or her optimal strategy, given the strategy chosen by the other player. Hence, he meant that with co-operation there can be overall growth for different players, if business market is considered. Or in any other scenario where there is interdependent condition of the players then there can be an optimum solution for betterment of all.

Prisoners dilemma

The prisoner's dilemma is a game invented at Princeton's Institute of Advanced Science in the 1950's. Many times, firms in a market face the Prisoners dilemma. It means to a situation when each firm adopts its dominant strategy but each could do better by cooperating. To clarify this, an example can be used in which: Two suspects are arrested for an armed robbery, and if convicted, each could receive a maximum sentence of 10 year imprisonment. However, unless one or both suspects confess, the evidence is such that they could be convicted only of possessing stolen goods, which carries a maximum sentence of 1 year prison. Each suspect is interrogated separately, and no communication was allowed between two of them. The judge promises each suspect that by confessing; he will go free while the other suspect, who does not confess, will receive the full 10 year sentence. If both suspects confess, each gets a reduced sentence of 5 years imprisonment. Hence, in this situation it is clear that, if two of the suspects follow the Adam Smiths dominant strategy then they both will confess and then there will be 5 year sentence for both. But if both suspects try to attain the Nash equilibrium by not confessing then there would be a 1 year sentence for both.
2. 3. A beautiful mind, 2001, (An Oscar award winning movie) Managerial Economics by Dominick Salvatore

However, in a sequence of games which can be considered as an iterated prisoner's dilemma, something different may happen. One or both players may fall into a pattern called "Tit for Tat", in which cooperation is rewarded and defection punished. Effectively, this means doing on this move whatever your partner did on the last. In a computer tournament of programs playing the prisoner's dilemma against one another, held by political scientist Robert Axelrod in 1980, a four line program playing "Tit for Tat" beat out much more complex and sophisticated programs. Yet "Tit for Tat" can only draw; it can never score more points in the game (fewer years, in this scenario) than its partner. On the other hand, a player who, out of moral obligation, cooperates on every move no matter what the partner does will be ignominiously defeated. His partner has no incentive to cooperate, but can defect and earn the greater payoff on every move. The moral: cooperation is best, but only if defection is immediately punished. Axelrod coined the phrase "shadow of the future" to describe the force that keeps a player cooperating. Someone who knows he will never meet you again may have nothing to lose by betraying you; someone who will have to deal with you many times more may be deterred, for fear of retaliation. Thus the future has a longer shadow in the second case. Human nature being what it is, in some prisoner's dilemmas, both the parties will always defect, thus scoring worse than they would if they always cooperated. The prisoner's dilemma is a simple but powerful idea; once you have hold of it, you see its applicability to every walk of life and all human experience. The prisoner's dilemma has been used to analyze problems in nuclear warfare, anthropology, biology and evolution.

Travelers dilemma 5
This game was devised by Kaushik Basu, an Indian economist who is currently the Chief Economic Adviser to the Government of India. When playing this simple game, people consistently reject the rational choice. In fact, by acting illogically, they end up reaping a larger reward--an outcome that demands a new kind of formal reasoning. Lucy and Pete, returning from a remote Pacific island, find that the airline has damaged the identical antiques that each had purchased. An airline manager says that he is happy to compensate them but is handicapped by being clueless about the value of these strange objects. Simply asking the travelers for the price is hopeless, he figures, for they will inflate it. Instead he devises a more complicated scheme. He asks each of them to write down the price of the antique as any dollar integer between 2 and 100 without conferring together.

4. 5.

The Ethical Spectacle September 1995, http://www.spectacle.org The Travelers Dilemma, An article in Scientific American magazine by Kaushik Basu, 20 May,2007

If both write the same number, he will take that to be the true price, and he will pay each of them that amount. But if they write different numbers, he will assume that the lower one is the actual price and that the person writing the higher number is cheating. In that case, he will pay both of them the lower number along with a bonus and a penalty--the person who wrote the lower number will get $2 more as a reward for honesty and the one who wrote the higher number will get $2 less as a punishment. For instance, if Lucy writes 46 and Pete writes 100, Lucy will get $48 and Pete will get $44. What numbers will Lucy and Pete write? What number would you write? Mr. Basu crafted this game, "Traveler's Dilemma, in 1994 with several objectives as to contest the narrow view of rational behavior and cognitive processes taken by economists and many political scientists. Traveler's Dilemma (TD) achieves those goals because the game's logic dictates that 2 is the best option, yet most people pick 100 or a number close to 100--both those who have not thought through the logic and those who fully understand that they are deviating markedly from the rational choice. Furthermore, players reap a greater reward by not adhering to reason in this way. Thus, there is something rational about choosing not to be rational when playing Traveler's Dilemma. In the years since he devised the game, TD has taken on a life of its own, with researchers extending it and reporting findings from laboratory experiments. These studies have produced insights into human decision making. Nevertheless, open questions remain about how logic and reasoning can be applied to TD. To see why 2 is the logical choice, consider a plausible line of thought that Lucy might pursue: her first idea is that she should write the largest possible number, 100, which will earn her $100 if Pete is similarly greedy. Soon, however, it strikes her that if she wrote 99 instead; she would make a little more money, because in that case she would get $101. But surely this insight will also occur to Pete, and if both wrote 99, Lucy would get $99. If Pete wrote 99, then she could do better by writing 98, in which case she would get $100. Yet the same logic would lead Pete to choose 98 as well. In that case, she could deviate to 97 and earn $99. And so on. Continuing with this line of reasoning would take the travelers spiraling down to the smallest permissible number, namely, 2. It may seem highly implausible that Lucy would really go all the way down to 2 in this fashion. That does not matter (and is, in fact, the whole point)--this is where the logic leads us. Game theorists commonly use this style of analysis, called backward induction. Backward induction predicts that each player will write 2 and that they will end up getting $2 each. Virtually all models used by game theorists predict this outcome for Travelers dilemma 4

that the two players earn $98 less than they would if they each naively chose 100 without thinking through the advantages of picking a smaller number.

Various games:
There are various games that can be played under the game theories applications. The problems of interest involve multiple participants, each of whom has individual objectives related to a common system or shared resources. Because game theory arose from the analysis of competitive scenarios, the problems are called games and the participants are called players. But these techniques apply to more than just sport, and are not even limited to competitive situations. In short, game theory deals with any problem in which each players strategy depends on what the other players do. Situations involving interdependent decisions arise frequently, in all walks of life. A few examples in which game theory could come in handy include: Friends choosing where to go have dinner Parents trying to get children to behave Commuters deciding how to go to work Businesses competing in a market Diplomats negotiating a treaty Gamblers betting in a card game And many more

These are real scenarios in life and if various games are to be discussed then some of them are discussed here: Sequential Game:
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To analyze a sequential game, first construct a game tree mapping out all of the possibilities. Then follow a strategic rule: look ahead and reason back. Look ahead to the very last decision, and assume that if it comes to that point, the deciding player will choose his/her optimal outcome. Back up to the second-to-last decision, and assume the next player would choose his/her best outcome, treating the following decision as fixed. Continue reasoning back in this way until all decisions have been fixed. Thats all there is to it. If we actually play out the game after conducting our analysis, we simply make the choices we identified at each of our decisions. The only time we even have to think is if another player makes a mistake.
6. Thinking Strategically by Dixit, Avinash K., and Barry J. Nalebuff, 1991

Then we must look ahead and reason back again, to see if our optimal strategy has changed. By noticing that, this procedure assumes that the other players are as smart as we are, and are doing the same analysis we should move forward. While this may not be the case, it is the only safe assumption. If it is correct, we will have made our best possible decision. For it to be incorrect, an opponent must choose an option not in his/her own best interests.

Iterated Game:

When players interact by playing a similar stage game, such as the prisoner's dilemma, numerous times, the game is called an iterated game. Unlike a game played once, a repeated game allows for a strategy to be contingent on past moves, thus allowing for reputation effects and retribution. In infinitely repeated games, trigger strategies such as tit for tat can encourage cooperation. So it is again a presentation of limitation of the Prisoners dilemma. It becomes obvious that over time the players get to know about the pros and cons of their subsequent decisions. Therefore the players get used to behave accordingly in a conservative manner for a balanced growth.

A puzzle of pirates:

The logic of mathematics sometimes leads to not so obvious conclusions. The rule here is that if the logic is perfect, the conclusions are sound, even if they conict with the intuition. In September 1998 Stephen M. Omohundro of Palo Alto, Calif., wrote a puzzle that falls into exactly this category. Ten pirates have gotten their hands on a hoard of 100 gold pieces and wish to divide the loot. They are democratic pirates, in their own way, and it is their custom to make such divisions in the following manner: The ercest pirate makes a proposal about the division, and everybody votes on it, including the proposer. If 50 percent or more are in favor, the proposal passes and is implemented forthwith. Otherwise the proposer is thrown overboard, and the procedure is repeated with the next ercest pirate. All the pirates enjoy throwing one of their fellows overboard, but if given a choice they prefer cold, hard cash. They dislike being thrown overboard themselves. All pirates are rational and know that the other pirates are also rational. Moreover, no two pirates are equally erce, so there is a precise pecking orderand it is known to them all. The gold pieces are indivisible, and arrangements to share pieces are not permitted, because no pirate trusts his fellows to stick to such an arrangement.
7. 8. Dictionary of gametheory.net Mathematical Recreations by Ian Stewart on euclid.trentu.ca

Its every man for his own self. What proposal should the ercest pirate make to get the most gold? For convenience, number the pirates in order of meekness, so that the least erce is number 1, the next least erce number 2 and so on. The ercest pirate thus gets the biggest number, and proposals proceed in reverse order from the top down. The secret to analyzing all such games of strategy is to work backward from the end. At the end, you know which decisions are good and which are bad. Having established that, you can transfer that knowledge to the next-to-last decision and so on. Working from the beginning, in the order in which the decisions are actually taken, doesnt get you very far. The reason is that strategic decisions are all about What will the next person do if I do this? so the decisions that follow yours are important. The ones that come before yours arent, because you cant do anything about them anyway. Bearing this in mind, the place to start is the point at which the game gets down to just two pirates, P1 and P2. The ercest pirate at this point is P2, and his optimal decision is obvious: propose 100 gold pieces for himself and none for P1. His own vote is 50 percent of the total, so the proposal wins. Now add in pirate P3. Pirate P1 knowsand P3 knows that he knows that if P3s proposal is voted down, the game will proceed to the two-pirate stage and P1 will get nothing. So P1 will vote in favor of anything that P3 proposes, provided it yields him more than nothing. P3 therefore uses as little as possible of the gold to bribe P1, leading to the following proposal: 99 for P3, 0 for P2 and 1 for P. The strategy of P4 is similar. He needs 50 percent of the vote, so again he needs to bring exactly one other pirate on board. The minimum bribe he can use is one gold piece, and he can offer this to P2 because P2 will get nothing if P4s proposal fails and P3s is voted on. So P4s proposal is 99 for himself, 0 for P3, 1 for P2 and 0 for P1. The approach taken by P5 is slightly different: he needs to bribe two pirates to get a winning vote. The minimum bribe he can use is two gold pieces, and the unique way he can succeed with this bribe is to propose 98 gold pieces for himself, 0 for P4, 1 for P3, 0 for P2 and 1 for P1. The analysis proceeds in the same manner, with each proposal uniquely prescribed to give the proposer the maximum reward while also ensuring a favorable vote. Following his pattern, P10 will propose 96 gold pieces for himself, one gold piece for each of pirates P8, P6, P4 and P2, and none for the odd-numbered pirates. This allocation solves the 10pirate version of the puzzle.

Hence, it can be seen that various games are there that can be played to understand the game theories and its implications on real life. There are also examples where it is proved that the logic might fail to find out the optimum solution while a nave idea may become beneficial.

Applications of game theory

There can be many applications of game theory such as: Von Neumann and Morgenstern originally applied their models of games to economic analysis. Each factor in the market, such as seasonal preferences, buyer choice, changes in supply and material costs, and other such market factors can be used to describe strategies to maximize the outcome and thus the profit. To simply study economics of the past and interactions of different factors in a matter can be use of game theory. It can also be used to investigate matters such as monetary distributions and their effects on other outcomes. Military strategists are using nowadays game theory to play war games. Now Sociologists also have taken an interest in the game theory, and have developed an entire branch dedicated to group decision making. Immunization procedures and vaccine or other medication tests are analyzed by 9 epidemiologists using game theory.
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Resource Allocation and Networking

Computer network bandwidth can be viewed as a limited resource. The users on the network compete for that resource. Their competition can be simulated using game theory models. No centralized regulation of network usage is possible because of the diverse ownership of network resources. The problem is of ensuring the fair sharing of network resources. For example, ten IWSB students on the same local network need access to the Internet. Each person, by using their network connection, diminishes the quality of the connection for the other users. This particular case is that of a volunteer's dilemma. That is, if one person abstains from using the network, the other people will be better off, but that person will be worse off. If a centralized system could be developed which would govern the use of the shared resources, each person would get an assigned network usage time or bandwidth, thereby limiting each person's usage of network resources to his or her fair share. Earlier, such a system remained impossibility, making the situation of sharing network resources a competitive game between the users of the network and decreasing everyone's utility. If comparing the situation at IWSB hostel and IWSB campus. This problem is there at IWSB campus but the package allocation to each student at IWSB hostel is the solution to the problem that is possible now to allocate equal bandwidth.
9. Game theory Applications from http://library.thinkquest.org 10. Applications of game theory on http://www-cs-faculty.stanford.edu

Biology

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Although the natural world is often thought of as brutal, dog-eat-dog type, cooperation exists between many different species. The reason behind this coexistence can be modeled using game theory. For example, birds called ziczacs enter crocodiles' mouths to eat parasites. This symbiosis allows crocodiles to achieve good oral hygiene and allows the ziczacs to get a decent meal. But any crocodile can easily eat a ziczac (defect). So why don't they? Apparently, over the eons of evolutionary action, the crocodiles and the ziczacs have learned the benefits of cooperation, the "equilibrium point." Of course, chances are that neither the crocodiles nor the ziczacs rationalize their behavior with game theory. But their behavior can still be modeled using game theory principles.

Economics

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Many of the interactions in the business world may be modeled using game theory methodology. A famous example is that of the similarity of the price-setting of oligopolies to the Prisoner's Dilemma. If an oligopoly situation exists, the companies are able to set prices if they choose to cooperate with each other. If they cooperate, both are able to set higher prices, leading to higher profits. However, if one company decides to defect by lowering its price, it will get higher sales, and, consequently, bigger profits than its competitor(s), who will receive lower profits. If both companies decide to defect, i.e. lower prices, a price war will ensue, in which case neither company will profit, since it will retain its market share and experience lower revenues at the same time. Prisoner's dilemma is not the only game theory model which can be used to model economic situations. Other models can be applied to different situations and, in many cases, can suggest the best outcome for all parties concerned.

Artificial Intelligence

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One of the marks that differentiate a human from a machine is the human's ability to make independent decisions based on environmental stimuli. Many computer programs that are required to make any sort of a decision are currently pre-programmed with the lists of decisions based on a number of conditions. However, if those conditions are not met in some way or are altered, computers have no way of making decisions they were not programmed to make. Recently, AI programs have been endowed with the ability to make new decisions unplanned for by their creators. A program that is able to do that would be capable of learning and would, in a lot of ways, resemble the human decisionmaking process. 9

Counter View to Game theory

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John Quiggin a game theory skeptic says that, My main problem has to do with the idea of a strategy and its role in equilibrium concepts such as the famous Nash equilibrium. A game outcome is Nash equilibrium if no player can gain by varying their own strategy, assuming that other players stick to their equilibrium strategy. The problem here is to say what a strategy is. In a game like chess or poker, this is easy: the rules say what each player can do and when they can do it. The same is true in some special kinds of economic situations, such as auctions. But most of the time, there is no book of rules, so the set of strategies has to be described as part of the model. If we look back at the Nash equilibrium idea, and put ourselves in the position of one of the players, it can be seen that theres really no difficulty with the definition of our own strategy. We can look at the outcomes that are available, given the other players strategy, and pick whichever one is best for us. The way in which we label our choices doesnt matter. Although its easy enough to make the point in specific instances that if we choose a different assumption about strategies we get a different equilibrium, economic theorists strongly resist the argument that this is a general problem and that economic interactions with a well-defined strategy space are the exceptions rather than the rule. This doesnt mean game theory cant be a useful source of insight, something Schelling in particular has shown. But its unlikely, in most cases, to yield definite and reliable predictions. Game theory skeptics want models that tell us, in a manner of speaking, how chess is played. Unfortunately for that you don't need a mathematician or an economist - you need a chess expert! Similarly within practical business settings, the people you would ask about business games would be - well, the players themselves. Here we see the benefit of the game theorist's approach: reducing games to a simple structure permits generalization to a wide variety of settings. The Prisoner's Dilemma, for example, arises over and over in many settings (war, business, resource management, and law enforcement). But as for not bringing out your queen to early - that principle makes sense only to chess (unless you happen to suffer an overdose of imagination.)

11. Whats wrong with the game theory by An article by John Quiggin, crookedtimber.org, on Oct 13, 2005 12. Nobel and Rational theory skeptics on http://rationalchoice.blogspot.in

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Endnote:
Game theory has been base for almost all the strategy courses. And apart from the simplicity of it, its application has been immense in each field in todays world. It is available to interested enthusiasts even in an indirect form such as movies, books or television series. Some prominent movies are A beautiful mind, The godfather, Ransom, Memento, Wall street, House of games etc. Some books are Prey, The godfather, The royal game, The mind game, Enduring love etc. And some TV series are Survivors, Friend and Foe, Friends, Weak links etc. Also, there are many documentaries made on the basis of game theory. Game theory has also been there in news over time. Eg: There was an article in NY times in which game theory was highlighted. Ie. By translating the properties of a ratchet into game theory, the scientific discipline that seeks to extract rules of nature from the gains and losses observed in games, Dr. Parrondo discovered that two losing games could combine to produce winnings. There was another article recently in Economic times about the betterment of Bangalore. The author says, If Bangalore is to become a major global hub for business, innovation and entrepreneurship, we need to focus on solutions as to how the myriad wonderful visions, desires and ideas voiced here and elsewhere can ever see the light of day. He suggests that, Greater civic responsibility is needed and forthcoming implementation through rule of law must be encouraged by civil society. If we all demand the same outcomes and stay the course, there is a greater chance of the global Bangalore hub materializing. It is clear that there is presence of game theory in all fields of study. But there is an assumption with it that all the players are rational and they possess common knowledge.

PS: All the content of this write-up is plagiarism free. References are given in footnotes. And the mentioned concepts are understood by the author.

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13. Paradox in game theory by Sandra Blakeslee in New York Times, Jan 25, 2000 14. Game theory hold answer for a better Bangalore by V. Ravichandran in Economic Times, May6, 2011

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