2008 Prentice-Hall, Inc.

Chapter 1
Game Theory
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Introduction
Game: a contest involving two or more
decision makers, each of whom wants to win.
Game theory: the study of how optimal
strategies are formed in conflict
Games classified by:
Number of players
Sum of all payoffs
Number of strategies employed
Zero-sum game: the sum of the losses must
equal the sum of the gains
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Payoff Table
Y
1
Use radio
Y2
Use newspaper
X1
Use radio
3 5
X2
Use newspaper
1 -2
Game player Ys strategies
G
a
m
e

P
l
a
y
e
r

X

s

S
t
r
a
t
e
g
i
e
s

+ entry, s X wins and Y loses
- entry, Y wins and X loses
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Outcomes
Store Xs Strategy Store Ys Strategy Outcome % change in
market share)
X
1
Radio Y
1
Radio X wins 3
Y loses 3
X
1
Radio Y
2
Newspaper X wins 5
Y loses 5
X
2
Newspaper Y
1
Radio X wins 1
Y loses 1
X
2
Newspaper Y
2
Newspaper X loses 2
Y wins 2
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Minimax Criterion
In a zero-sum game, each person can
choose the strategy that minimizes the
maximum loss
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Minimax Criterion
Y
1
Y
2
Minimum
X
1
3 5 3
X
2
1 -2 -2
Maximum 3 5
Minimum of maximums
Maximums of
minimums
Saddle point
Note: an equilibrium or 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.
This is a pure strategy game
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Pure Strategy
Whenever a saddle point is present, the
strategy a player should follow will
always be the same, regardless of the
strategy of the other player.
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Pure Strategy
Second Players (Y)
Strategies
Y
1
Y
2
First Players (X)
Strategies
X
1
3 5
X
2
1 -2
Ys pure
strategy
Xs pure
strategy
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Pure Strategy
Minimax Criterion
Player Ys
Strategies
Minimum Row
Number
Y1 Y2
Player Xs
strategies
X1 10 6 6
X2 -12 2 -12
Maximum Column
Number
10 6
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Mixed Strategy Game
Y1
P
Y2
1-P
Expected Gain
X1
Q
4 2 4P+2(1-P)
X2
1-Q
1 10 1P+10(1-p)
4Q+1(1-Q) 2Q+10(1-q)
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Solving for P & Q
4P+2(1-P) = 1P+10(1-P)
or: P = 8/11 and 1-p = 3/11
Expected payoff:
EP
X
=1P+10(1-P)
=1(8/11)+10(3/11) = 3.46


4Q+1(1-Q)=2Q+10(1-q)
or: Q=9/11 and 1-Q = 2/11
Expected payoff:
EP
Y
=3.46
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Dominance
A strategy can be eliminated if all its
games outcomes are the same or
worse than the corresponding outcomes
of another strategy
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Domination
Y
1
Y
2
X
1
4 3
X
2
2 20
X
3
1 1
Initial Game
Y
1
Y
2
X
1
4 3
X
2
2 20
X3 is a dominated strategy
Game after removal of dominated strategy
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Domination
Y
1
Y
2
Y
3
Y
4
X
1
-5 4 6 -3
X
2
-2 6 2 -20
Initial Game
Y
1
Y
4
X
1
-5 -3
X
2
-2 -20
Game after dominated strategies are removed