Introduction

to Game
Theory
Chapter 9
Managerial Economics
Outline

• What is Game Theory?

• Key Elements of a Game
• Neumann and Morgenstern’s Game Theory
• Nash Equilibrium
• Tucker’s Prisoner’s Dilemma
I. What is Game Theory?
What is Game Theory?

• Game theory is a branch of applied mathematics that

provides tools for analyzing situations in which parties, called
players, make decisions that are interdependent.

This interdependence causes each

player to consider the other player’s
possible decisions, or strategies, in
formulating his own strategy.
A solution to a game describes the
optimal decisions of the players, who
may have similar, opposed, or mixed
interests, and the outcomes that may
result from these decisions.
II. Key Elements of a Game
Key Elements of a Game

Payoffs
(What are their
incentives?)
Strategies Information
(What are their (What do they
options?) know?)

Players Rationality
(How do they
(Who is interacting?)
think?)
III. Neumann & Morgenstern’s
Game Theory
John Von
Neumann

Hungarian-born
American
mathematician
 Oskar
Morgenstern

German-born
American
economist
 To solve
problems in
economics
Number of Players

n-person game
One-person game Two-person game (with n greater than
two)
One-person Game

• With no opponents, the player only

needs to list available options and then
choose the optimal outcome
• Also known as games against nature
• One-person games hold little interest
for game theorists
 Example

there does not exist a conscious opponent

Two-person Game

A. Two-Person Constant-Sum Games

both players cannot gain (they may or may not lose,
but they cannot both gain)
Players has completely opposed interests
games of total conflict
also called games of pure competition
it never helps a player to give an adversary
information

2 types:
Game of Perfect Information
Game of Imperfect Information
 Examples
Game of Game of
Perfect Information Imperfect Information

Each player knows everything Players do not know all of

about the game at all times their opponents’ cards
“Saddlepoint”

• is the outcome that rational players would choose

• always exists in games of perfect information but may or may
not exist in games of imperfect information
• By choosing a strategy associated with this outcome, each
player obtains an amount at least equal to his payoff at that
outcome, no matter what the other player does

*Payoff - the value of the game

Two-person Game

B. Two-Person Variable-Sum Games

players may all be winners or losers
the players have both common and opposed
interests
a player may want an opponent to be well-
informed

2 types:
Cooperative Games
Noncooperative Games
 Examples
Cooperative Games Noncooperative Games

Players can communicate and Players may communicate but

make binding agreements they cannot make binding
agreements such as an
enforceable contract
Example
N-person Game

• players are not allowed to communicate

and make binding agreements

2 types:
Sequential
Simultaneous
 Example

Sequential
A (1) survive alone,
(2) survive with one opponent
(3) survive with both opponents
(4) not survive, with no opponents alive
(5) not survive, with one opponent alive
(6) not survive, with both opponents
alive
Thus, surviving alone is best, dying
alone is worst.
B C
 Example
Simultaneous
A Outcome 1:
There will always be shooting, leaving
one or no survivors.
Outcome 2:
There will always be shooting, leaving
one or no survivors.
Outcome 3:
There may be zero, one (any of A, B, or
C), or three survivors, but never two.
B C
 Example
Sequential Simultaneous

Thinking ahead about the unpleasant They must decide in ignorance of each
consequences of shooting first or others’ intended actions. This situation is
colluding with another player to do so, common in life: people often must act
nobody will shoot or collude. before they find out what others are doing.
Nash Equilibrium
 John F.
Nash
American
mathematician
Proposed the one well-
known cooperative
solution to two-person
variable-sum games
Received the Nobel
Prize for Economics in
1994 for this and related
work he did in game
theory
Nash Equilibrium

Nash equilibrium occurs when each player is seeking his or

her best possible strategy, while fully aware of the strategies
that everybody else is pursuing.
Example
Tucker’s Prisoner’s Dilemma
Albert W.
Tucker
American
mathematician
Formulated the
celebrated prisoner’s
dilemma (PD) to
illustrate the kinds of
difficulties that arise in
two-person
noncooperative
variable-sum games
Prisoner’s Dilemma

• It demonstrates how communication between the participants

can drastically alter their best strategy.
Example
Let’s Play the Game!
References:

• Dixit and Nalebuff: Thinking Strategically

• Dutta: Strategies and Games: Theory and Practice
• www.gametheory.net
• Contents Summary: Slideshare from University of Tehran-MBA, Fall
2008 (Game Theory Presentation)
• Britannica