What is game theory in business?, Study notes of Quantitative Techniques

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GAME THEORY

Game Theory and Economics

Game theory is the study of how people

behave in strategic situations.

Strategic decisions are those in which

each person, in deciding what actions to

take, must consider how others might

respond to that action.

Game Theory and Economics

 Therefore, it also affects the profits of

other firms.

 Each firm knows that its profit depends

not only on how much it produced but

also on how much the other firms

produce.

What is a Game?

A game is a situation where the participants’

payoffs depend not only on their decisions,

but also on their rivals’ decisions.

This is called Strategic Interactions:

My optimal decisions will depend on what others do in the game.

Matching pennies

Each player selects one side of a coin;

if the coins match player 1 wins and gets

1 dollar from player 2;

if the coins don’t match player 2 wins

and gets 1 dollar from player 1.

Matrix Representation of

Matching Pennies

Player 2 Head Tail Player 1 Head 1,-1 -1, Tail -1,1 1,-

Matrix Representation of

Boeing-Airbus game

Airbus Develop Do not develop Boeing Develop -50,-50 80,- Do not develop

Solutions of the Games

To predict what will be the

solution/outcome of the game we need

some tools:

dominated and dominant strategies; Nash equilibrium.

Matrix Representation of

Prisoners Dilemma

Bonnie Confess Do not Confess Clyde Confess 16,16 0, Do not Confess

We want to predict the outcome of the game

Bonnie Confess Do not Confess Clyde Confess 16,16 0, Do not Confess

Suppose that Clyde decides to confess. What is the best decision for Bonnie?

Dominated and Dominant Strategy

Dominant Strategy:

a strategy that gives higher payoffs no matter what the opponent does;

Dominated Strategy:

a strategy is dominated if there exists another strategy that is dominant.

So far we have only assumed that each

player is rational to determine the outcome

of the game.

We want to predict the outcome of the game

Bonnie Confess Do not Confess Clyde Confess 16,16 0, Do not Confess

Suppose that Bonnie decides to confess. What is the best decision for Clyde?

Outcome of the Game

Bonnie Confess Do not Confess Clyde Confess 16,16 0, Do not Confess

A Modified Prisoners Dilemma:

Clyde is proud of not confessing

Bonnie Confess Do not Confess Clyde Confess 16,16 0, Do not Confess