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Original Title: Game Theory

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THEORY

Game theory may be defined as – “ a

body of knowledge that deals with

making decisions when two or more

intelligent and rational opponents are

involved under conditions of conflict and

competition.”

Every game must have a character of

competition and two or more players involved in

it with some predetermined rules.

The game results either in victory of one or the

other or sometimes a draw.

Therefore, game represents a conflict between

two parties or countries or persons.

Player Y

H T

H

Player X

X pays Rs. 60 to Y Y pays Rs. 80 to X

T

Thus,

A competitive situation =

Game

Gain of one player is the loss of other player

zero

A strategy is a course of action taken by one of

the participants in a game and the pay-off is the

result or outcome of the strategy.

An Example:

Firm 2

No Price

Price Increase

Change

No 10,10 100, -30

Price

Firm 1 Change

-20, 30 140, 35

Price

Increase

Players adopts pessimistic attitude and plays

safe.

corresponds to the maximum of the minimum

gains for his different courses of action.

Similarly, player B wants to play safe.

to the minimum of the maximum losses.

Course of action or strategy which puts the player

in the most preferred position, irrespective of the

strategy of his competitors.

decreased pay-off for the player.

Expected pay-off of the play when all the players

of the game follow their optimal strategies.

(Saddle Point

Exists)

Method Method Programmin

g Method

With saddle point…….

It is an Two person Zero –sum game.

It uses pay-off Matrix.

It involves Maximin principle and Minimax

principle.

Its objective is to bring out Optimal strategies

for both players.

To derive Value of the Game.

• The maximizing player arrives at his optimal strategy on the

basis of the maximin criterion, while the minimizing player

strategy is based on minimax value. The game is solved

when the maximin value equals minimax value. And when

they both equalize that particular point is called as saddle

point.

• Develop the payoff- matrix.

• Identify row minimums and select the largest of these

as player one’s maximin strategy.

• Identify column maximums and select the smallest of

these as the opponents minimax strategy.

• If the maximin value equals minimax value, the game

is a pure strategy game and that value is saddle point.

• The value of the game of player one is the maximin

value and to player two , the value is the nagative of

minimax value.

According to the principle the size of

the game’s pay-off matrix can be

reduced by eliminating a course of

action that is so inferior to another

that it can never be used.

Such a course of action is said to be

dominated by others.

A dominant strategy is the one that

is optimal no matter what the

opponent does.

In general the following rules of dominance are used to

reduce the size of the pay-off

If all the elements in the ith row of the pay-off matrix are

less than or equal to the corresponding elements of the

other row (say the jth row) then the ith strategy is

dominated by the jth strategy.

If all the elements in the rth column of the pay-off matrix

are greater than or equal to the corresponding elements

of the other column (say the sth column) then the rth

strategy is dominated by the sth strategy.

Player B

B1 B2 B3 B4

7 6 8 9

A1

A2 -4 -3 9 10

Player A

A4 3 0 4 2

10 5 -2 0

A1 gives more gain than A3 in all conditions (for all strategies of B) i.e. A1

dominates A3.

Player B

B1 B2 B3 B4

7 6 8 9

A1

A2 -4 -3 9 10

Player A

A4 10 5 -2 0

Payoff matrix for Advertising game

Firm A and B sell competing products and are deciding whether to undertake

advertising or not

Firm B

10,5 15,0

Advertise

Firm A

6,8 10,2

Don’t Advertise

Modified Advertising Game

However, not every game has a dominant strategy for each player.

Firm B

10,5 15,0

Advertise

Firm A

6,8 20,2

Don’t Advertise

Suppose there are two competitors, X and Y, planning to sell soft

drinks on a beach. They both sell the same soft drinks at the same

price.

The beach is 200 yards long, and the sunbathers are spread

evenly across its length.

Where on the beach should they locate?

Ocean

0 A 200

Beach

The “beach location game” can help us

understand a variety of phenomena.

petrol pumps, or several roadside

restaurants, or several car dealers are

located close to each other on a two- or

three- mile stretch of road.

(Games Without Saddle Point)

Two breakfast food manufacturing firms A & B are competing for an increased market share. To

improve its market share both the firms decide to launch the following strategies :

A2, B2 = Decrease Price

A3, B3 = Maintain Present Strategy

A4, B4 = Increase Advertising

The pay-off matrix describes the Increase in market share for firm A & decrease in market hare

for firm B.

Firm B

B1 B2 B3 B4

A1 35 35 25 5

Firm A A2 30 20 15 0

A3 40 50 0 10

A4 55 60 10 15

EXAMINE THE OPTIMAL SRTATEGIES FOR EACH FIRM & THE VALUE OF THE

GAME

STEPS:

2. Observe if pay-off can be reduced in size by rules of dominance.

We note 2nd row is dominated by 1st row because pay-offs are less

attractive for firm A.

Firm B

B1 B2 B3 B4

A1 35 35 25 5

A2 30 20 15 0

Firm A

A3 40 50 0 10

A4 55 60 10 15

Thus deleting 2nd row reduced matrix becomes :

Firm B

B1 B2 B3 B4

A1 35 35 25 5

Firm A A3 40 50 0 10

A4 55 60 10 15

in 1st column

Therefore

2nd column is dominated by 1st column because pay-offs are less attractive

for B. (Delete 2nd column)

Thus deleting 2nd column reduced matrix becomes :

Firm B

B1 B3 B4

A1 35 25 5

Firm A

A3 40 0 10

A4 55 10 15

Further comparing row 2 & 3 , then column 1 & 2 , delete less attractive

row

column’s from A’s & B’s point of view.

Prob.

Firm B

B3 B4

Firm A p1

A1 25 5

p2

A4 10 15

Prob. q1 q2

No saddle point, so use mixed strategies.

For firm A :

Let p1 & p2 be prob. of selecting strategy A1 (Give coupons) & A4( Increase

Advertising) respectively.

B1 25p1 +10(1-p1)

B2 5p1 + 15(1-p1)

Expected gain should be equal

Player A would play first strategy A1 with prob. 1/5 & A2 with prob. 4/5

For Firm B :

B4 (Increasing Advertising)

A1 25q1 +5(1-q1)

A2 10q1 + 15(1-q1)

By Equating

25q1 +5(1-q1) = 10q1 + 15(1-q1)

Optimal strategy for both manufacturers :

( Increasing

Advertising) 20% time. (p1)

strategy

B4 ( Increasing Advertising) 40% time.(q1)

(5 X 1/5) + (15 X 4/5) = 13

(10 X 2/5) + (15 X 3/5) = 13

Pepsi calculated the market share of

two products, Pepsi and Mountain Dew,

against its major competitor Coca Cola’s

three products, Coca Cola, Fanta and

Sprite and tried to find out the effect of

additional advertisement in any of its

products against the other.

Pepsi/Coca Cola Sprite Fanta Coca Cola

Mountain Dew 15 6 7

Pepsi 10 12 20

Pepsi/Coca Sprite Fanta Coca Minimum

Cola Cola

Mountain 15 6 7 6

Dew

Pepsi 10 12 20 10

Maximum 15 12 20

Maximin= 10 & Minimax=

12

Minimax

=> No saddle point.

Pepsihas two products, Pepsi and

Mountain Dew, with probability of their

getting selected for advertisement equal to

P1 and P2, respectively, such that:

P1 + P2= 1

or P2= 1 – P1.

Foreach of the pure strategies

available to Coca cola, i.e. its three

products (Coca Cola, Fanta and

Sprite), expected pay-off of Pepsi can

be represented by plotting straight

lines.

Pepsi/Coca Cola Sprite Fanta Coca Cola

Mountain Dew 15 6 7

Pepsi 10 12 20

Coca cola’s Product Pepsi’s pay-

off(market share)

Sprite 15p2 + 10p1

Pepsi/ Coca cola Sprite Fanta Coca Cola

Mountain Dew 15 6 7

Pepsi 10 12 20

•Coca Cola’s strategy is

to yield worst result to

Pepsi.

•Pay-offs

to Pepsi are

represented by lower

boundary.

•Pepsi’s strategy is to

maximize its expected

gain, i.e. market share.

•Maximum pay-off is at

highest point on this

lower boundary.

found at P, at the

intersection of two lines,

representing the pay-offs

corresponding to Sprite

and Fanta.

Pepsi/ Coca Cola Sprite Fanta

Mountain Dew 15 6

Pepsi 10 12

off(market share)

Sprite 15p2 + 10p1

Pay-off corresponding to Sprite = Pay-off corresponding to Fanta

Since, p1 + p2 = 1

Putting

p2 = 1 – p1 and solving…

Gives

p1 = 9/11 or 81.81%

p2 = 2/11 or 18.18%

and

Pepsi 81.81% times of total advertisement in order to obtain

optimum result irrespective of rival product’s strategy.

The non-zero-sum games refer to a

situation where there exists a jointly

preferred outcome. Existence of a

jointly preferred outcome means that

both players may be able to increase

their pay-offs through some form of an

operation or agreement concerning

actions to be chosen.

Cooperative games : Players are assumed to be equal to

realize that it is mutually advantageous to cooperate on any

& every one which is likely to benefit at least one of players

without affecting them adversely.

between participants & there is no way to reach

enforcement agreements.

‘Prisoners Dilemma’

Suspect 2

Not No Prison Term 15 years prison term for 1;

Confess for both Suspended sentence for 2

Suspect 1

Confess Suspended sentence 8 years prison term for both

for 1;

15 years prison term

for 2

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