GAME THEORY
NGUYEN BICH DIEP, PhD
CONCEPT
• Game theory is the study of strategic interactions among economic
agents.
• Strategic interactions: a situation in which the pay-off of one economic
agent is dependent upon the choices of others.
CONCEPT
• Essential elements of a game:
• Players
• Strategies
• Payoffs
• Each player’s goal is to maximize their individual payoff.
TYPES OF GAMES
• Simultaneous vs. sequential games
• Simultaneous games are games in which players take strategic actions
at the same time without knowing what move the other has chosen, e.g.
rock, paper, scissors
• Sequential games are games where players take turns and move
consecutively. One player observes the move of the other player and
then makes their play and so on, e.g. chess
TYPES OF GAMES
• Single-play vs. repeated games
• Single-play games are played once, and then the game is over, e.g. a
game of rock, paper, scissors played once to determine a winner.
• Repeated games are simultaneous move games played repeatedly by
the same players, e.g. repeated plays of rock, paper, scissors, with the
first player to win five times being the winner.
REPRESENTATION
NORMAL FORM
Player B
Sports Comedy
Sports 3,2 1,1
Player A
Comedy 0,0 2,3
REPRESENTATION
EXTENSIVE FORM
player
node
(decision point)
strategy
payoffs
REPRESENTATION
EXTENSIVE FORM
player
node
(decision point)
strategy
information set
payoffs
DOMINANT STRATEGIES
• The prisoners’ dilemma
Player B
Confess Deny
Confess -3,-3 0,-6
Player A
Deny -6,0 -1,-1
DOMINANT STRATEGIES
• Dominant strategy: a strategy for which the payoffs are always
greater than any other strategy no matter what the opponent does.
• Dominated strategy: a strategy for which the payoffs are always
lower than any other strategy no matter what the opponent does.
• Equilibrium in dominant strategies: outcome of a game in which
each player is doing the best it can regardless of the actions of its
opponent.
• Each player has a dominant strategy and plays it.
DOMINANT STRATEGIES
• Each player has a dominant strategy – Confess, and the game has a
dominant strategy equilibrium – (Confess, Confess).
• However, If they both chose Deny, both of them would have been
better off. In this case, the equilibrium in dominant strategies is not
Pareto efficient.
• Pareto efficiency: a situation where no action or allocation is available
that makes one individual better off without making another worse off.
DOMINANT STRATEGIES
• Oligopolies as a prisoners’ dilemma
Firm B
High Low
production production
High
16,16 20,15
production
Firm A
Low
15,20 18,18
production
DOMINANT STRATEGIES
• When only one of the two player has a dominant strategy
Firm B
Don’t
Advertise
advetise
Advertise 10,5 15,0
Firm A
Don’t
6,8 20,2
advetise
NASH EQUILIBRIUM
• Nash equilibrium: a set of strategies (or actions): each player is
doing the best it can given the actions of its opponent.
• Player A’s choice is optimal, given player B’s choice, and player B’s choice is
optimal, given player A’ choice
• Because each player has no incentive to deviate from its Nash
strategy, the strategies are stable.
NASH EQUILIBRIUM
• Pure coordination game
Player B
Left Right
Left 10,10 0,0
Player A
Right 0,0 10,10
EXERCISE
• The product choice problem
Firm B
Crispy Sweet
Crispy -5,-5 10,10
Firm A
Sweet 10,10 -5,-5
NASH EQUILIBRIUM
• Battles of the sexes
Player B
Football Shopping
Football 10,5 0,0
Player A
Shopping 0,0 5,10
NASH EQUILIBRIUM
• Stag hunt
Player B
Stag Hare
Stag 8,8 0,7
Player A
Hare 7,0 5,5
MIXED STRATEGIES
• Pure strategy: strategy in which a player makes a specific choice or
takes a specific action.
• Mixed strategy: strategy in which a player makes a random choice
among two or more possible actions, based on a set of chosen
probabilities.
• Some games do not have any Nash equilibria in pure strategies.
However, once we allow for mixed strategies, every game has at least
one Nash equilibrium.
MIXED STRATEGIES
• Battles of the sexes: more general case
Player B
Football Shopping
Football 10,5 0,0 p
Player A
Shopping 0,0 5,10 1–p
q 1–q
MIXED STRATEGIES
• In a mixed strategy equilibrium, player A should have:
10q + 0(1 – q) = 0q + 5(1 – q)
→ q = 1/3 (1)
• Similarly, player B should have:
5p + 0(1 – p) = 0p + 10(1 – p)
→p = 2/3 (2)
• The mixed-strategy Nash equilibrium is [(2/3,1/3),(1/3,2/3)].
SEQUENTIAL GAMES
• Backward induction
