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Chapter 1 Introduction
Brief History
Game Theory Defined
Importance and Applications of Game
Theory
Methodology
Classification of Game Models
Elements of a Game
2
Outline
Chapter 2 Two-Person, Zero-Sum Game
Conservative Strategies
Minimax Criterion
Nash Equilibrium
Dominance
Pure Strategy Game
Mixed Strategy Game
Analytical Method
Graphical Method
Linear Programming Solution
3
Outline
Chapter 5 Applications
4
INTRODUCTION
Brief History of Game Theory
7
What is Game Theory?
8
Why Study Game Theory?
9
Why Study Game Theory?
Because the press tells us to …
Marketing strategies
Labor-management negotiations
Potential mergers
International military conflicts
Competitive bidding
Advertising
Etc.
12
Methodology
13
Strategy
a comprehensive plan of action
14
Classification of Game Models
15
Elements of a Game
Players
Set of possible actions
Information available
Payoff consequences (in matrix form)
Players’ preference over payoffs
16
Payoff Matrix
Brilliant Lights
Use radio Use newspaper
Use radio 3 5
Bright Lights
Use
newspaper 1 -2
Payoffs are shown only for the row player (Bright Lights).
Brilliant Light’ payoffs are just the negative of each number.
17
Illustration 1
Consider two lighting fixture stores, namely,
Bright Lights and Brilliant Lights. The
respective market shares have been stable up
until now, but the situation may change. The
owner of Bright Lights has developed two
distinct advertising strategies – using radio
spots and newspaper ads. Upon hearing this,
the owner of Brilliant Lights also proceeds to
prepare radio and newspaper ads. The next
slide shows what will happen to current market
shares if both stores begin advertising.
18
Bright Lights’ Payoff Table
Brilliant Lights
Use radio Use newspaper
Use radio 3 5
Bright Lights
Use
newspaper 1 -2
Use radio 3 5
Bright Lights
Use
newspaper 1 -2
Assumption:
Row player tries to maximize winnings
while column player tries to minimize
losses.
20
Two-Person, Zero-Sum Game
There are only two players.
One player wins a certain amount and
the other player loses the same amount
(i.e., the sum of the gains and losses for
both players is zero).
Assumption:
Each player moves to maximize his own
payoff without knowing in advance how the
opponent will move.
21
MINIMAX CRITERION
Conservative Strategies
Playing safe by adopting the conservative strategy
of assuming the worst:
The row player chooses the move where
smallest payoff is as large as possible (to guard
himself when his opponent manage to select
the column that will result in the smallest
payoff).
The column player (wanting to maximize his
payoff) minimizes his opponent’s payoff by
choosing the column where maximum entry is
as small as possible.
23
Minimax Criterion
an approach to selecting strategies that
will minimize losses for each player
Bad news: Knowing game theory does not
guarantee winning
Column max 4 1 5
minimax
26
Illustration 2
Consider B Row min
−1 − 3 5 - 3
A − 2.5 1 3 -2.5
4 0 − 2 -2 maximin
Column max 4 1 5
minimax
27
Illustration 3
28
Remark
29
PURE STRATEGY GAMES
Pure Strategy
(or Strictly Determined) Games
neither player can benefit from the
knowledge that the opponent is using
the conservative strategy
the strategy of each player does not
change regardless of the other player’s
strategy.
if and only if its payoff matrix has a
saddle point (or minimax point)
31
Saddle Point
33
Remark
34
Illustration 4
35
Air Speed
pricing service
pricing 25 18
Express Airlines
service -15 15
37
Exercise
Find the saddle point/s, the conservative
strategies, and the value of each of the
following strictly determined games:
a) b) 3 54 3
8 0 − 2
− 6 4 1 2 4
0 − 2
4 3 2 1 − 6 5 0
0 2 6 − 1
38
Illustration 4
Two video rental chains, VCity and Vvid, are thinking
about opening a new store in one of three cities. If
chain VCity locates its new store in city 1, its estimate
earning per year will be PhP 225,000 more than chain
Vvid if Vvid also locates in city 1 and PhP 90,000 more
if Vvid locates in city 3, but it will earn PhP 450,000
less than Vvid if Vvid locates in city 2. If chain Vcity
locates in city 2, it will earn PhP 900,000, PhP
675,000, and PhP 540,000 more than Vvid if Vvid
locates in cities 1, 2, and 3, respectively. Finally, if
chain VCity locates in city 3, it will earn PhP 675,000
and PhP 450,000 more than Vvid if Vvid locates in
cities 1 and 3, respectively, and it will earn PhP
225,000 less than Vvid if Vvid locates in city 2. Where
should each chain locate its new store?
39
Solution
VCity
city 1 city 2 city 3
city 1
Vvid city 2
city 3
40
Dominance
41
Procedure for Finding the Reduced
Form of a Matrix Game
Compare the rows in the matrix. Delete any
row that is dominated by another row (i.e.,
each entry is less than the corresponding
entry of the other row).
Compare the columns in the matrix. Delete
any column that dominates another column
(i.e., each entry is greater than the
corresponding entry of the other column).
Repeat Steps 1 and 2 to eliminate all
redundant rows and columns.
42
Illustration
Consider the following matrix game:
C
3 1 0 − 3
R
7 − 1 1 6
2 4 5 1
43
Reduced form of the game:
R
− 1 6
4 1
44
Exercise
2 −1 4 3 −2 6 2
− 1 5 4 −1 − 2 0
1
− 1 3 − 4 − 1 0 6 − 2
2 1 5 0
45
Nash Equilibrium
Occurs when each player's strategy is optimal,
given the strategies of the other players.