CIA1-

GAME THEORY
ANSWER ANY 4 QUESTIONS
TOTAL MARKS=20 MARKS

1. What do you mean by strategic games? Provide suitable examples. (5

MARKS)

Strategic games, in the context of game theory in economics, are games

where players make decisions with the understanding that their choices will
not only impact their own outcomes but also the outcomes of other players.
These games involve strategic interactions where each player's decision
depends not only on their preferences but also on their expectations of how
other players will behave. Game theory provides a framework for analysing
such situations and predicting the likely outcomes.

Here are a few key components and examples of strategic games:

1. Players: Strategic games involve at least two players, but they can
include many more.

2. Strategies: Each player has a set of possible strategies or actions they can
choose from. These strategies determine how a player will behave in the
game.

3. Payoffs: The outcomes or payoffs associated with each combination of

strategies chosen by the players. Payoffs represent the players' preferences
and can be in the form of monetary rewards, utility, or any other relevant
measure.

Examples of strategic games in economics include:

1. Prisoner's Dilemma: In this classic example, two suspects are arrested for
a crime, and each has the option to cooperate with the other by remaining
silent or betray the other by confessing. The payoffs depend on the choices
made by both suspects, and it illustrates a situation where both players have
a dominant strategy to confess, leading to a suboptimal outcome for both.
 2. Cournot Competition: In this game, two firms decide how much output to
produce in a market with limited demand. Each firm chooses its output level
to maximize its profit, taking into account the expected response of the other
firm. This game is used to model oligopolistic competition.

3. Bertrand Competition: In this scenario, two firms set prices for identical
products. Consumers will buy from the firm with the lowest price. Firms
choose their prices strategically, considering how the other firm will price its
product.

4. Battle of the Sexes: This game represents a coordination problem between

two individuals. They want to meet each other but have different preferences
for where to go
These are just a few examples of strategic games in economics. Game
theory helps economists and researchers analyse and understand how
individuals or firms make decisions in situations of conflict or cooperation,
providing insights into various economic phenomena and outcomes.

2. Explain prisoner’s dilemma in the context of strategic games with utility

preference and pay-off-matrix). (5 MARKS)

The Prisoner's Dilemma is a classic example in game theory that illustrates

the concept of strategic games with utility preferences and pay-off matrices.
It involves two suspects who have been arrested and are facing a choice:
cooperate (remain silent) or betray (confess). The outcomes and payoffs are
represented in a payoff matrix, which shows how the players' decisions
affect their individual outcomes. Let's break down the Prisoner's Dilemma in
the context of a utility preference and pay-off matrix:

Players: Two suspects, A and B.

Strategies: Each suspect can choose one of two strategies: "Cooperate" (C)
by remaining silent or "Betray" (B) by confessing to the crime.

Payoff Matrix:

```
| A Cooperates (C) | A Betrays (B) |
-------------------------------------------------
B Cooperates | A gets 2, B gets 2 | A gets 0, B gets 3 |
-------------------------------------------------
B Betrays | A gets 3, B gets 0 | A gets 1, B gets 1 |
```

In the payoff matrix:

- The first element in each cell represents the payoff for Player A.
- The second element represents the payoff for Player B.

Interpreting the Payoff Matrix:

1. If both suspects cooperate (C-C), they both receive a moderate sentence,

and each gets a utility of 2.

2. If both suspects betray (B-B), they both receive a harsh sentence, and
each gets a lower utility of 1.

3. If one suspect cooperates (C) while the other betrays (B), the one who
betrays gets a significantly reduced sentence (3), while the one who
cooperates receives a very harsh sentence (0).

Analysis:

In the Prisoner's Dilemma, the dilemma arises because each player's rational
choice (maximizing their own utility) leads to a suboptimal outcome for
both when considered together.

- If Player A expects Player B to cooperate (C), Player A is tempted to betray

(B) because it results in a better individual outcome (3 > 2).
- Likewise, if Player B expects Player A to cooperate (C), Player B is also
tempted to betray (B) for the same reason.

As a result, both players often end up betraying each other, leading to the
outcome (B-B), which is worse for both in terms of their combined utility
compared to the outcome (C-C).

This situation highlights a common theme in strategic games: individual

rationality can lead to collectively suboptimal outcomes. If both suspects
could somehow trust each other to cooperate, they would both be better off.
However, the fear of being betrayed by the other player leads to a situation
 where both players betray, resulting in a less desirable outcome for both –
hence, the "dilemma" in the Prisoner's Dilemma.

3. Provide suitable examples of Classical examples of game theory for the

following (a) Conflict of Sales, (ii) Advertising War. (5 MARKS)

Certainly, here are suitable examples of classical game theory scenarios for
both "Conflict of Sales" and "Advertising War":

(a) Conflict of Sales:

Imagine two competing companies, Company X and Company Y, that sell

similar products. They are engaged in a price war, trying to capture a larger
share of the market. This scenario can be modelled as a game theory
situation where each company chooses a pricing strategy, and their payoffs
depend on the prices they set and the market share they gain.

-Players: Company X and Company Y.

-Strategies: Each company can choose a pricing strategy, such as setting a
low price or a high price.
- Payoff: Payoffs could be represented in terms of profit. For example:
- If both companies set low prices, they may attract more customers, but
their profits may be lower due to reduced margins.
- If one company sets a low price and the other sets a high price, the one
with the low price may gain a larger market share but might also experience
lower profits.
- If both companies set high prices, they may have higher profit margins,
but they might lose customers to competitors.

Game theory can be used to analyse this situation and predict how the
companies will strategically choose their prices and what the resulting
market outcomes will be.

(b) Advertising War:

Consider two leading soft drink companies, Company A and Company B,

competing for market dominance. They engage in an advertising war to
capture consumers' attention and loyalty.
 - Players: Company A and Company B.
- Strategies: Each company can choose its advertising expenditure level,
such as high advertising or low advertising.
- Payoff: Payoffs could be represented in terms of market share, brand
loyalty, or revenue. For example:
- If both companies invest heavily in advertising, they may both experience
increased brand recognition and market share.
- If one company invests heavily in advertising while the other does not,
the one that advertises heavily may gain a competitive advantage.
- If both companies reduce their advertising spending, they might maintain
their current market positions, but they risk losing ground to other
competitors.

Game theory can be applied to analyse how the advertising strategies of

these companies affect their market positions, brand loyalty, and overall
success in the soft drink industry. It can help determine the optimal level of
advertising expenditure for each company to maximize their goals, whether
that's market share, profitability, or another metric.

4. Illustrate the concept of Arm’s race with Pay-off Matrix and utility
preference in the context of strategic games. (5 MARKS)

The concept of an arms race can be illustrated using a simplified payoff

matrix and utility preferences in the context of a strategic game involving
two countries, Country A and Country B. In this scenario, both countries
have the option to either "Arm" (increase their military capabilities) or
"Disarm" (reduce their military capabilities). The payoffs will represent their
utility preferences, taking into account factors like national security,
resources, and international relations.

Players: Country A and Country B.

Strategies: Each country can choose to "Arm" (A) or "Disarm" (D).

Payoff Matrix:

```
| Country A Arms (A) | Country A Disarms (D) |
---------------------------------------------------------
Country B Arms (A) | 3, 3 | 0, 4 |
---------------------------------------------------------
Country B Disarms (D) | 4, 0 | 1, 1 |
```

In this simplified payoff matrix:

- The first element in each cell represents the utility (or benefit) to Country
A.
- The second element represents the utility to Country B.

Interpreting the Payoff Matrix:

1. If both countries choose to "Arm" (A-A), they both invest heavily in their
military capabilities. However, they also bear the costs of military spending,
resulting in a moderate utility of 3 for each country.

2. If Country A arms while Country B disarms (A-D), Country A gains a

strategic advantage (3), while Country B, having disarmed, is left vulnerable
(0).

3. If both countries choose to "Disarm" (D-D), they avoid the costs and
tensions associated with military buildup, resulting in moderate utility (1)
for each country.

4. If Country A disarms while Country B arms (D-A), Country A is at a

strategic disadvantage (4), while Country B enjoys a military advantage (4).

Analysis:

In this arms race scenario, both countries face a dilemma similar to the
Prisoner's Dilemma. Their dominant strategies, from an individual
standpoint, may be to "Arm" because it results in the highest utility for each
country. However, when both countries pursue this strategy (A-A), they both
end up with moderate utility and face the financial and security burdens of
an escalating arms race.

On the other hand, if both countries choose to "Disarm" (D-D), they avoid
the costly arms race and enjoy moderate utility, but they may worry about
being vulnerable to potential aggression from each other or other nations.

The arms race illustrates how countries can find themselves in a situation
where pursuing their own interests can lead to suboptimal outcomes for both
 when considered collectively. Game theory helps analyse such situations and
explore strategies that may lead to cooperation and disarmament, ultimately
benefiting both countries in terms of stability and reduced military
expenditures.

5. Explain the battle of Sexes WITH Pay-off Matrix and explain its relevance
in the context of game theory. (5 MARKS)

The "Battle of the Sexes" is a classic game theory scenario that explores
coordination and conflict in decision-making. It is often used to illustrate
situations where individuals have different preferences but still need to
coordinate their actions to achieve a desirable outcome. This scenario is
particularly relevant in understanding human behavior in relationships,
negotiations, and other cooperative contexts.

Scenario Description:
Imagine a couple, Alice and Bob, who want to spend an evening together.
However, they have different preferences for how they would like to spend
their time. Alice prefers going to a ballet, while Bob prefers attending a
football game. They both agree that spending time together is more
important than going alone, but they need to coordinate their choice to have
an enjoyable evening.

Players: Alice and Bob.

Strategies: Each player can choose either "Ballet" (B) or "Football" (F) as
their preferred activity for the evening.

Payoff Matrix:

```
| Alice chooses Ballet (B) | Alice chooses Football (F) |
-------------------------------------------------------------------
Bob chooses Ballet (B) | 2, 1 | 0, 0 |
-------------------------------------------------------------------
Bob chooses Football (F) | 0, 0 | 1, 2 |
```

In the payoff matrix:

- The first element in each cell represents the payoff (satisfaction or utility)
to Alice.
- The second element represents the payoff to Bob.

Interpreting the Payoff Matrix:

1. If both Alice and Bob choose "Ballet" (B-B), they get a payoff of 2 and 1,
respectively. This outcome is preferable to both, but Alice gets her preferred
activity, resulting in a slightly higher payoff.

2. If Alice chooses "Ballet" (B) while Bob chooses "Football" (F), Alice's
payoff is 0, as she doesn't enjoy football. Bob, however, gets his preferred
activity and receives a payoff of 2.

3. Conversely, if Alice chooses "Football" (F) while Bob chooses "Ballet"

(B), the payoffs are reversed, with Alice receiving a payoff of 2 and Bob
getting 0.

4. If both Alice and Bob choose "Football" (F-F), they get a payoff of 1
each, which is better than their least preferred outcome (0-0).

Relevance in Game Theory:

The Battle of the Sexes scenario is relevant in game theory for several
reasons:

1. Coordination Games: It illustrates the challenges of coordination when

individuals have different preferences but still want to achieve a mutually
beneficial outcome. It highlights the need for communication and
cooperation to avoid conflicts.

2. Nash Equilibrium: In this scenario, there are two Nash equilibria (B-B
and F-F), which are stable outcomes where neither player has an incentive to
unilaterally change their strategy. However, one outcome may be more
preferred by both players, leading to the question of how to reach it.

3. Strategic Decision-Making: It demonstrates how strategic decisions are

influenced by individual preferences and the desire to achieve the best
possible outcome within a group or partnership.
 Overall, the Battle of the Sexes is a simple yet insightful game theory
example that helps us understand the dynamics of coordination, cooperation,
and conflict resolution in various real-world situations where individuals
must make choices together.

6. Explain the concept of Dominant strategy via Prisoner’s Dilemma. (5

MARKS)

The concept of a dominant strategy is often explained using the classic

example of the Prisoner's Dilemma in game theory. In the Prisoner's
Dilemma, two suspects are arrested for a crime and have the option to
cooperate (remain silent) or betray (confess). Each player wants to minimize
their sentence, so they must choose the strategy that leads to the best
outcome regardless of what the other player chooses.

Here's how the concept of dominant strategy works in the context of the
Prisoner's Dilemma:

Players:Two suspects, Player A and Player B.

Strategies: Each player can choose to "Cooperate" (C) by remaining silent or

"Betray" (B) by confessing to the crime.

Payoff Matrix:

```
| A Cooperates (C) | A Betrays (B) |
-------------------------------------------------
B Cooperates | A gets 2, B gets 2 | A gets 0, B gets 3 |
-------------------------------------------------
B Betrays | A gets 3, B gets 0 | A gets 1, B gets 1 |
```

In this payoff matrix:

- The first element in each cell represents the payoff for Player A.
- The second element represents the payoff for Player B.

Now, let's analyse dominant strategies:

 1. Dominant Strategy for Player A: A dominant strategy is a strategy that
yields a better outcome for a player regardless of what the other player
chooses. In this case, Player A's dominant strategy is to "Betray" (B)
because:

- If Player B chooses "Cooperate" (C), Player A gets a higher pay off by

betraying (3 > 2).
- If Player B chooses "Betray" (B), Player A still gets a higher pay off by
betraying (1 > 0).

So, "Betray" is Player A's dominant strategy.

2. Dominant Strategy for Player B: Similarly, Player B's dominant strategy

is also to "Betray" (B) because:

- If Player A chooses "Cooperate" (C), Player B gets a higher pay off by

betraying (3 > 2).
- If Player A chooses "Betray" (B), Player B still gets a higher pay off by
betraying (1 > 0).

So, "Betray" is Player B's dominant strategy.

In the Prisoner's Dilemma, both players have dominant strategies to betray.

However, when both players follow their dominant strategies and betray
each other, they end up in a suboptimal outcome (B-B) with lower combined
utility compared to both cooperating (C-C). This highlights the tension
between individual rationality (choosing the dominant strategy) and
collective rationality (achieving the best overall outcome), which is a key
concept in game theory.

7. Explain the theory of Rational Choice in the context of Gane THEORY. (5

MARKS)

The theory of rational choice is a fundamental concept in game theory,

economics, and social sciences. It provides a framework for understanding
how individuals make decisions when faced with multiple choices and
limited resources, particularly in the context of strategic interactions and
competitive situations like those studied in game theory.
Here's an explanation of the theory of rational choice in the context of game
theory:

1. Utility Maximization: At the core of rational choice theory is the idea that
individuals are rational actors who seek to maximize their utility. Utility is a
measure of satisfaction or well-being, and rational individuals make choices
that lead to the highest possible utility given their preferences and
constraints.

2. Preferences: Rational individuals have well-defined preferences. They can

rank different outcomes or states of the world based on how much
satisfaction or utility each outcome provides them. Preferences can vary
from person to person and can encompass various factors, including
personal values, desires, and objectives.

3. Choice Set: Rational individuals make choices from a set of available

options or strategies. In game theory, this choice set is often referred to as a
player's strategy space. The set of strategies includes all the possible actions
or decisions that a player can take in a given situation.

4. Information: Rational choice assumes that individuals have complete and

relevant information about the available choices and their potential
consequences. They use this information to evaluate their options and make
decisions that maximize their expected utility.

5. Consistency: Rational choice theory assumes that individuals are

consistent in their decision-making. If they prefer option A over option B
and prefer option B over option C, then they must prefer option A over
option C. In other words, preferences should satisfy transitivity.

6. Optimal Decision-Making: Rational individuals choose the option that

offers the highest expected utility. They compare the utility associated with
each option in their choice set and select the one that maximizes their
expected satisfaction.

In the context of game theory, the theory of rational choice is applied to

analyse strategic interactions between rational players. Each player aims to
make choices that maximize their own utility, taking into account their
beliefs about what the other players will do. Game theory allows us to
model and predict how rational individuals or entities will behave in
situations of conflict, cooperation, coordination, and competition.
 However, it's important to note that the outcomes predicted by the theory of
rational choice may not always align with what we observe in the real
world. Factors like bounded rationality (limited cognitive abilities),
emotional considerations, and imperfect information can influence decision-
making and may lead to deviations from purely rational behaviour.
Nevertheless, rational choice theory provides a useful baseline for
understanding decision-making in strategic contexts and forms the
foundation of game theory analysis.

8. Explain any 5 of the following-(5) Marks

Pure strategy (1)
Mixed Strategy (1)
Optimal Strategy (1)
Min-Max -Max-Min Principle (1)
Saddle Point (1)
Fair Game (1)

Certainly, I'll explain each of these concepts briefly:

1. Pure Strategy:
- A pure strategy in game theory refers to a specific, deterministic choice
that a player makes in a game. It involves selecting one action or option with
certainty. Players using pure strategies do not randomize their decisions.

2. Mixed Strategy:
- A mixed strategy involves a player randomizing their choices among
multiple pure strategies with specific probabilities assigned to each strategy.
Players using mixed strategies introduce an element of randomness into
their decision-making.

3. Optimal Strategy:
- An optimal strategy is a strategy that maximizes a player's expected
utility or minimizes their expected cost given their beliefs about the actions
of other players. It is the best strategy for a player to adopt in a given game.

4. Min-Max -Max-Min Principle:

- The Min-Max principle is used in zero-sum games (games where one
player's gain is another player's loss). It involves finding a strategy for the
 minimizing player (minimizer) that maximizes their worst-case outcome
(the minimum payoff). Conversely, it finds a strategy for the maximizing
player (maximize) that minimizes their worst-case outcome (the maximum
payoff). These two solutions are called the Min-Max and Max-Min
strategies.

5. Saddle Point:
- In a two-player zero-sum game, a saddle point is a specific cell in the
payoff matrix where the value of the game is achieved. It is a situation
where the Min-Max and Max-Min strategies coincide, leading to a stable
outcome. The values in this cell represent the optimal payoff for both
players.

6. Fair Game:
- A game is considered fair when, in equilibrium, the expected payoffs for
all players are zero. In other words, no player has an advantage, and the
game does not Favor any particular player. Fair games can be used as a basis
for decision-making in situations where fairness or equity is important.

These concepts are fundamental to the study of game theory, helping us

understand how players make decisions and strategize in various
competitive and cooperative situations.

What is Nash Equilibrium?

Nash Equilibrium is a game theory concept that determines the optimal solution in
a non-cooperative game in which each player lacks any incentive to change his/her
initial strategy. Under the Nash equilibrium, a player does not gain anything from
deviating from their initially chosen strategy, assuming the other players also keep
their strategies unchanged. A game may include multiple Nash equilibria or none
of them.

Nash equilibrium is one of the fundamental concepts in game theory. It

conceptualizes the behavior and interactions between game participants to
determine the best outcomes. It also allows predicting the decisions of the players
if they are making decisions at the same time and the decision of one player takes
into account the decisions of other players.

Nash equilibrium was discovered by American mathematician, John Nash. He was

awarded the Nobel Prize in Economics in 1994 for his contributions to the
development of game theory.
Imagine two competing companies: Company A and Company B. Both companies
want to determine whether they should launch a new advertising campaign for
their products.

If both companies start advertising, each company will attract 100 new customers.
If only one company decides to advertise, it will attract 200 new customers, while
the other company will not attract any new customers. If both companies decide
not to advertise, neither company will engage new customers. The payoff table is
below:

Company A should advertise its products because the strategy provides a better
payoff than the option of not advertising. The same situation exists for Company
B. Thus, the scenario when both companies advertise their products is a Nash
equilibrium.
Example of Multiple Nash Equilibrium

Under some circumstances, a game may feature multiple Nash equilibria.

John and Sam are registering for the new semester. They both have the option to
choose either a finance course or a psychology course. They only have 30 seconds
before the registration deadline, so they do not have time to communicate with
each other.

If John and Sam register for the same class, they will benefit from the opportunity
to study for the exams together. However, if they choose different classes, neither
of them will get any benefit.

In the example, there are multiple Nash equilibria. If John and Sam both
register for the same course, they will benefit from studying together for the
exams. Thus, the outcomes finance/finance and psychology/psychology are
Nash equilibria in this scenario.
Q1) Discuss the Cournot model. How is it diff from Bertrand model? Provide example.\
Ans.: The Cournot model and the Bertrand model are two fundamental models in the field of
industrial organization and game theory, used to analyze competition between firms in an
oligopoly (a market with a small number of large firms). Here's a discussion of each model
along with their key differences and an example:
Cournot Model:
The Cournot model was developed by French economist Augustin Cournot in 1838. In this
model, firms compete by choosing the quantity of a homogeneous product they will produce.
The key assumptions of the Cournot model are:
1. Number of Firms: There are two or more firms in the market.
2. Homogeneous Product: The product produced by all the firms is identical.
3. Simultaneous Decision-Making: Firms choose their quantities simultaneously, without
knowing the quantities chosen by their rivals.
4. Profit Maximization: Firms aim to maximize their profits.
5. Constant Marginal Cost: Each firm has a constant marginal cost of production.
The equilibrium of the Cournot model is found by solving for the Nash equilibrium, where
each firm's quantity choice is optimal given the quantity choices of its competitors.
Bertrand Model:
The Bertrand model, named after French economist Joseph Bertrand, assumes that firms
compete by setting prices for their products rather than quantities. The key assumptions of the
Bertrand model are:
1. Number of Firms: There are two or more firms in the market.
2. Homogeneous Product: The product produced by all the firms is identical.
3. Simultaneous Decision-Making: Firms set their prices simultaneously, without knowing
the prices set by their rivals.
4. Perfect Information: Consumers have perfect information about prices.
5. Profit Maximization: Firms aim to maximize their profits.
The equilibrium of the Bertrand model is found by solving for the Nash equilibrium, where
each firm's price choice is optimal given the price choices of its competitors.
Key Difference:
The key difference between the Cournot and Bertrand models lies in the choice of strategic
variable - quantity in Cournot and price in Bertrand. This difference has significant
implications for market outcomes and competition.
Example:
Let's consider a simplified example with two firms, Firm A and Firm B, in a duopoly market.
Cournot Model Example:
- Both firms simultaneously choose quantities (qA and qB) to produce.
- Total market demand is given by P = 100 - (qA + qB), where P is the price.
- Assume both firms have the same constant marginal cost of production, MC = 10.
Bertrand Model Example:
- Both firms simultaneously choose prices (PA and PB).
- Total market demand is given by Q = 200 - (PA + PB), where Q is the quantity demanded.
- Assume both firms have zero marginal cost of production, MC = 0.
Solving for the Nash equilibrium in each model will provide the optimal quantities/prices for
both firms, and you can compare the outcomes. Keep in mind that these are simplified
examples and real-world situations may involve more complex considerations.

Q2) Discuss the Stackleberg model in GT. How is it diff from the Cournot model? Provide
examples w relevant applications
Ans: The Stackelberg model is another important concept in game theory, particularly in the
context of strategic interactions between firms. It is named after the German economist
Heinrich von Stackelberg.
Stackelberg Model:
In the Stackelberg model, there are two or more firms, but unlike in the Cournot model where
firms make decisions simultaneously, in the Stackelberg model, one firm (the leader) makes
its decision first, and then the other firm(s) (the followers) make their decisions, knowing the
leader's decision. The leader anticipates the reactions of the followers when making its
choice.
Key Assumptions:
1. Number of Firms: There are two or more firms in the market.
2. Homogeneous Product: The product produced by all the firms is identical.
3. Sequential Decision-Making: The leader makes its decision first, followed by the
followers.
4. Perfect Information: All firms have perfect information about costs, demand, and the
strategies of other firms.
Stackelberg vs. Cournot:
The main difference between the Stackelberg and Cournot models lies in the timing of
decisions. In the Stackelberg model, the leader chooses its quantity (or price) first, and then
the followers react, while in the Cournot model, both firms choose quantities simultaneously.
Example with Relevant Applications:
Example: Duopoly with Differentiated Products
Let's consider a simplified example with two firms, Firm A and Firm B, in a duopoly market
producing slightly different products.
Stackelberg Model:
- Firm A, as the leader, chooses its quantity first (qA).
- Firm B observes qA and then chooses its quantity (qB).
Cournot Model:
- Both firms simultaneously choose quantities (qA and qB) to produce.
Relevant Applications:
1. Automobile Industry: In the automobile industry, one company may introduce a new model
or technology, setting the pace for the rest of the industry. For example, Tesla's introduction
of electric cars disrupted the market and prompted other companies to invest in electric
vehicle technology.
2. Video Game Consoles: When a new video game console is released, it often becomes the
leader in the market, influencing the strategies of other console manufacturers.
3. Airline Industry: Airlines may adjust their flight schedules and routes based on the actions
of competitors. For example, if one airline starts offering a new route, other airlines might
respond by adjusting their own routes and schedules.
4. Pharmaceutical Industry: A pharmaceutical company that develops and patents a new drug
becomes the leader in the market. Other companies must then decide how to respond,
whether by developing a competing drug or seeking a different market niche.
These examples illustrate how the Stackelberg model can be applied in various industries
where firms make sequential decisions based on the actions of their competitors. The leader's
advantage in setting the initial strategy can have significant implications for market outcomes
and competition.

Q3) Discuss the concept of mixed Nash equilibrium. Provide suitable examples with
appropriate application.
Ans.: A mixed Nash equilibrium is a concept in game theory that extends the notion of a Nash
equilibrium to games where players may not have a pure strategy that is a best response to the
strategies of the other players. Instead, players choose their strategies probabilistically,
leading to a distribution of possible strategies.
Definition:
In a mixed Nash equilibrium, each player assigns a probability distribution over their set of
possible pure strategies. These probabilities represent the likelihood of choosing each
strategy. No player has an incentive to unilaterally deviate from their chosen strategy, given
the strategies chosen by the other players.
Example: Matching Pennies Game
A classic example to illustrate the concept of a mixed Nash equilibrium is the "Matching
Pennies" game. In this game, two players simultaneously choose either "Heads" or "Tails" by
placing a penny face up or face down.
- Player 1's payoff matrix:
Heads Tails
Heads 1 -1
Tails -1 1

- Player 2's payoff matrix is the negative of Player 1's matrix.

Analysis:
In this game, there is no dominant strategy for either player. That is, regardless of what the
other player does, neither player has a pure strategy that is always better than the other.
To find a mixed Nash equilibrium, we assume that each player chooses "Heads" with
probability p and "Tails" with probability (1-p). The expected payoff for Player 1 can be
calculated as:
E1 = p(1) + (1-p)(-1) = 2p - 1
Similarly, the expected payoff for Player 2 is:
E2 = p(-1) + (1-p)(1) = 1 - 2p
To find the mixed Nash equilibrium, we look for values of p where neither player has an
incentive to deviate. This means that both players are indifferent between their strategies.
In this case, when p = 0.5, Player 1 gets 0 and Player 2 gets 0. This is a mixed Nash
equilibrium because neither player can improve their payoff by unilaterally changing their
strategy.
Application:
This concept is applicable in various real-world situations where decision-makers have
uncertainty or incomplete information. For example:
1. Pricing Strategies: In a competitive market, firms might adopt mixed strategies for pricing
to avoid predictability and deter price wars.
2. Political Campaigns: Political candidates might use mixed strategies for advertising,
choosing different messages or platforms to appeal to different segments of the electorate.
3. Military Strategies: In military conflict, commanders might use mixed strategies to
introduce unpredictability in their tactics, making it harder for the opponent to anticipate their
moves.
The concept of mixed Nash equilibrium is particularly relevant when there is
uncertainty or when players want to introduce strategic variability into their
decisions. It provides a way to analyze and understand strategic interactions in
these complex situations.

Q4) Discuss the subgame Nash equilibrium with examples.

Ans.: A subgame Nash equilibrium is a concept in game theory that applies to sequential
games, specifically those with extensive form representation (i.e., games with a tree-like
structure representing the sequence of moves). It identifies strategies that are optimal at every
subgame (subsequent stage of the game) that can be reached from a given decision point.
Definition:
In a sequential game, a subgame refers to any portion of the game tree that starts at a specific
decision node and includes all of its descendants. A subgame Nash equilibrium is a set of
strategies, one for each player, such that each player's strategy is a best response to the
strategies of the other players at every subgame.
Example: The Centipede Game
The Centipede Game is a classic example to illustrate the concept of subgame Nash
equilibrium. In this game, two players can take turns to either continue or stop the game. The
game starts with a prize of 1 unit of money and doubles with each turn if the players
continue. However, if one player chooses to stop, that player takes the entire prize.
Here is the payoff structure for Player 1 (P1) and Player 2 (P2):
- If the game ends at the first turn (Player 1 stops), P1 gets 1 unit and P2 gets 0 units.
- If the game ends at the second turn (Player 2 stops after Player 1 continues), P1 gets 2 units
and P2 gets 2 units.
- If the game ends at the third turn (Player 1 stops after Player 2 continues), P1 gets 4 units
and P2 gets 4 units.
- ...
Analysis:
In this game, there is a natural subgame at every decision point (each turn). For example, if
Player 1 continues, the subgame becomes a new version of the Centipede Game with one less
turn.
In a subgame Nash equilibrium, each player's strategy must be optimal at every subgame.
This means that the backward induction principle can be applied. Starting from the last
subgame and moving backwards, players' actions are determined.
Subgame Nash Equilibrium Outcome:
The unique subgame Nash equilibrium outcome in the Centipede Game is for both players to
continue at every turn until the final turn. This leads to an extensive sequence of
continuations, maximizing the overall payoff.
Application:
While the Centipede Game is a theoretical example, the concept of subgame Nash
equilibrium is relevant in many real-world situations involving sequential decision-making,
such as:
1. Bargaining Situations: For example, in negotiations, the optimal action at each step may
depend on what has happened in previous rounds.
2. Investment and Strategic Timing: When firms are deciding when to enter or exit a market,
they must consider how their actions affect their rivals' decisions.
3. Game Strategies in Sports: Coaches and players must make decisions based on the current
state of the game and how it may unfold in the future.
Overall, subgame Nash equilibrium provides a powerful tool for analyzing sequential games
and understanding the strategies that lead to optimal outcomes at every stage of the game.

Q5) Discuss mixed nash equilibrium with examples

Ans.: A mixed Nash equilibrium is a concept in game theory that applies to games where
players have uncertainty or randomness in their strategies. It extends the idea of a Nash
equilibrium, which is a set of strategies where no player has an incentive to unilaterally
deviate, to situations where players may choose their strategies with probabilities.
Definition:
In a mixed Nash equilibrium, each player assigns a probability distribution over their set of
possible pure strategies. These probabilities represent the likelihood of choosing each
strategy. No player has an incentive to unilaterally deviate from their chosen strategy, given
the strategies of the other players.
Example: Rock-Paper-Scissors Game
A classic example to illustrate the concept of a mixed Nash equilibrium is the game of Rock-
Paper-Scissors. In this game, two players simultaneously choose one of three options: Rock,
Paper, or Scissors. Each option beats one of the other options and loses to the remaining one.
- Player 1's strategy space: {Rock, Paper, Scissors}
- Player 2's strategy space: {Rock, Paper, Scissors}
Let's represent the payoffs for Player 1 and Player 2 as follows (with higher numbers
indicating better payoffs for the respective player):
Rock Paper Scissors
Rock 0,0 -1,1 1,-1
Paper 1,-1 0,0 -1,1
Scissors -1,1 1,-1 0,0

Analysis:
In this game, there is no dominant strategy for either player. That is, regardless of what the
other player does, neither player has a pure strategy that is always better than the other.
To find a mixed Nash equilibrium, we assume that each player chooses each strategy with a
certain probability. Let's denote the probability that Player 1 plays Rock as p, Paper as q, and
Scissors as 1-p-q. Similarly, for Player 2, let's denote the probabilities as r, s, and 1-r-s.
Now, the expected payoff for Player 1 when playing Rock is:
E1(Rock) = p*(-1) + q*1 + (1-p-q)*(-1)
The expected payoff for Player 1 when playing Paper is:
E1(Paper) = p*1 + q*(-1) + (1-p-q)*1
Setting up similar equations for Player 2, we can solve for the probabilities p, q, r, and s that
make both players indifferent between their strategies.
Mixed Nash Equilibrium Outcome:
In the Rock-Paper-Scissors game, a mixed Nash equilibrium is achieved when both players
choose their strategies with equal probabilities (p=q=r=s=1/3). This leads to a situation where
neither player can gain an advantage by unilaterally changing their strategy.
Application:
The concept of mixed Nash equilibrium is widely applicable in various real-world situations
where decision-makers have uncertainty or incomplete information:
1. Pricing Strategies in Oligopoly: Firms might choose to set prices with probabilities to
introduce unpredictability and avoid price wars.
2. Political Campaign Strategies: Candidates may use mixed strategies for campaign
messaging to appeal to different segments of the electorate.
3. Game Theory in Sports: Athletes or teams might use mixed strategies in competitive sports
to introduce unpredictability in their tactics.
4. Military Strategies: Commanders might use mixed strategies to introduce unpredictability
in their tactics, making it harder for the opponent to anticipate their moves.
In all these scenarios, players use mixed strategies to introduce an element of unpredictability
or to account for uncertainty in the actions of their opponents. The concept of mixed Nash
equilibrium provides a framework for analyzing and understanding strategic interactions in
these complex situations.

Q7) Differentiate between Cournot, Stackleberg, Bertrand with applications and examples.
Ans.: Certainly! Cournot, Stackelberg, and Bertrand are three different models used in game
theory to analyze competition between firms in oligopolistic markets. They each have distinct
assumptions and strategic elements. Here's a comparison along with relevant applications and
examples:
1. Cournot Model:
- Assumptions:
 - Firms simultaneously choose quantities to produce.
- Products are homogenous (identical).
- Each firm believes the output of the other firms to be fixed.
- Example:
- Consider two firms, A and B, producing a homogenous product. If A produces \(q_A\)
units and B produces \(q_B\) units, total output in the market is \(Q = q_A + q_B\). Firms
maximize profits given this total output.
- Application:
- Oil Production: OPEC (Organization of the Petroleum Exporting Countries) often operates
under Cournot-style competition where member countries collectively set production levels.
2. Stackelberg Model:
- Assumptions:
- One firm (the leader) makes a decision first, and then the other firm(s) (the followers)
make their decisions, knowing the leader's choice.
- Products are homogenous.
- Perfect information.
- Example:
- Consider a market with two firms, Firm A and Firm B. If Firm A acts as the leader, it
chooses its quantity first. Then, Firm B observes A's choice and selects its own quantity.
- Application:
- Game Consoles: When a new video game console is released, the company introducing it
effectively becomes the leader, influencing the strategies of other console manufacturers.
3. Bertrand Model:
- Assumptions:
- Firms compete by setting prices, not quantities.
- Products are homogenous.
- Perfect information.
- Example:
- Consider two firms, A and B, competing by setting prices for their products. If A sets a
price \(P_A\) and B sets a price \(P_B\), consumers will buy from the firm with the lower
price.
- Application:
- Airline Ticket Pricing: Airlines compete by setting ticket prices. If two airlines offer the
same route, consumers are likely to choose the cheaper option.
Comparisons:
1. Strategic Variable:
- Cournot: Firms choose quantities.
- Stackelberg: One firm chooses quantity first, others respond.
- Bertrand: Firms set prices.
2. Information Assumptions:
- Cournot: Firms have imperfect information about rivals' quantities.
- Stackelberg: Perfect information.
- Bertrand: Perfect information.
3. Timing of Decisions:
- Cournot: Simultaneous quantity choice.
- Stackelberg: Leader makes decision first, followers respond.
- Bertrand: Simultaneous price setting.
Applications:
- Cournot Model:
- Oil Industry: OPEC members choosing production levels.
- Telecom Industry: Companies determining network capacity.
- Stackelberg Model:
- Automobile Industry: One company may lead with a new technology, influencing rivals.
- Retail Industry: A dominant retailer may set prices, with others following suit.
- Bertrand Model:
- Airline Industry: Airlines compete by setting ticket prices.
- Fast Food Industry: Fast food chains often compete based on pricing.
Remember, real-world situations may involve a combination of elements from these models,
and firms' strategies can be influenced by various factors beyond the scope of these models.
These models serve as useful simplifications to understand and analyze strategic interactions
in different types of markets.