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Chapter 6: Theory of Game

Game Theory:
Game theory is a type of decision theory in which one’s choice of action is
determined after taking into account all possible alternatives available to an
opponent playing the same game.
Classification:
1. Two-Person Game:
If a game involves only two players (competitors), then it is called a two-
person game.
2. N-Person Game:
If a game involves N number of players, where players are more than two,
the game is referred to as N-person game.
3. Zero-Sum Game:
 A game in which one player wins what the other player loses is called a
zero-sum game.
 Winner’s winnings is always equal to the loser’s losses i.e. the sum of
amounts won by all winners is equal to sum of amounts lost by all
losers.
 So the net gain is zero across all players.
 Also called constant-sum game.
4. Non-Zero Sum Game:
A game in which the sum of gains and losses is not equal.
5. Two person-zero sum game:
- A game with only two players (say, player A and player B) is called a two
person zero sum game, if the losses of one player are equivalent to the
gains of the other, so that the sum of the net gains is zero.
- Two person zero sum game are also called rectangular games as these
are usually represented by a payoff matrix in rectangular form.
Assumptions of the Game theory
a) There are finite number of competitors and there is conflict of interests
between them.
b) Each player has available to him a finite number of possible strategies
(courses of action). The list may not be same for each player.
c) Each player knows not only his own list of possible course of action but
also of his opponent. But does not know which one is going to be
chosen.
d) The payoff is fixed and determined in advance.
e) Players simultaneously select their respective courses of action.
f) Players have to make individual decisions without direct communication.
g) The decisions are made simultaneously and also announced
simultaneously so that neither player has an advantage resulting from
direct knowledge of the other player’s decision.
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h) By convention, the payoff table for the player whose strategies are
represented by rows (say player A) is constructed.
i) Player ‘A’ attempts to maximize gains and player B minimize losses.
j) Each player acts rationally.

Elements
1. Player: The competitors are referred to as player. A player may be
individual, a group of individual, or an organization.
2. Pay-off:
 Payoffs is a quantitative measure of satisfaction or (dissatisfaction) a
person gets at the end of the play i.e. the outcome of playing a
game.
 It is the net gain, the strategy brings to the player for any given
counter-strategy of the competitor.
 The net gain is measured in terms of the objective of the firm (player)
i.e., increase in profits, etc.
3. Pay-off Matrix: The matrix which shows the outcome of the game as
player select their particular strategies is known as the payoff matrix.
In other words, it is the table showing outcomes or pay-offs of different
strategies of the game.
It is assumed that each player knows not only his own list of possible
course of action but also of his opponent.
E.g., pay-off matrix of a two-person zero sum game:

In this pay-off matrix, positive pay-off is the gain to maximizing player (A)
and loss to minimizing player (B).E.g., if company A chooses strategy A1 and
company B chooses strategy B1, then A’s gain is 8 and B’s loss is 8.
4. Optimal strategy:
• The particular strategy by which a player optimizes his gains or losses
without knowing the competitor's strategies.
• Any deviation from this strategy results in a decreased pay-off for the
player.
5. Value of the game:
• It is the expected pay –off of the play when all the players of the game
follow their optimal strategies.
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• The game is called fair if the value of the game is zero and unfair if it is
non-zero.
6. Saddle Point:
• The saddle point of a payoff matrix is that position of the matrix where
the maximum of row minima (i.e. maximin) coincides with the minimum of
column maxima (i.e. minimax). In other words, Saddle point is a payoff
matrix element which is both a minimum of its row and a maximum of its
column.
• The pay off at the saddle point is the value of the game.

Strategies
A player's strategy is defined as a plan of action that determines the
player's move at each stage of the game (depending on the circumstances
of the game at each stage), from the player's first move all the way to the
player's final move.
 The strategy for a player is the list of all possible actions (moves or
courses of action) that he will take for every payoff (outcome) that
might arise.
 It is assumed that the rules governing the choices are known in
advance to the players.

Types of Strategies
Pure Strategy:
 It is the decision rule in which the best strategy for each player is to
play one strategy throughout the game.
 Each player knows in advance what the is going to do and know about
all strategies out of which he always selects only one particular strategy
regardless of the other player’s strategy.
 There is deterministic situation and the objective of the player is to
maximize profit or minimize losses.
 This is the case if and only if, the pay-off matrix contains a saddle point.
 Pure strategy use Maximin – minimax principle
a) Maximin Criterion: The player who is maximizing his outcome or
payoff finds out his minimum gains from each strategy (course of
action) and selects the maximum value out of these minimum gains.
b) Minimax Criterion: In this criterion the minimizing player determines
the maximum loss from each strategy and then selects with
minimum loss out of the maximum loss list.

Mixed strategy:
 When the players use a combination of strategies and each player is
always kept guessing as to which courses of action is to be selected by
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the other players at a particular occasion, then this is known as mixed

strategies.
 In mixed strategy, each player employs different strategies at different
times in the game.
 It is the decision rule in which courses of action are to be selected on a
particular occasion with some fixed probability.
 There is a probabilistic situation and mixed strategy is a selection among
pure strategies with mixed probabilities.
 Mixed strategy means a situation where a saddle point does not exist,
the maximin (minimax) principle for solving a game problem breaks down.

Rule of dominance:
 The rule of dominance are used to reduce the size of payoff matrix and
convert a bigger game into a smaller game.
 These rule helps in deleting certain rows and columns of the payoff
matrix that are inferior(less attractive) to at least one of the remaining
rows and columns.
 Rows and columns once deleted can never be used for determining the
optimum strategy for both players.
 The rule of dominance are especially used for the evaluation of ‘two-
person zero-sum’ games without a saddle point (equilibrium) point.

General Rule of Dominance:

i) If all the elements if a row, say row ‘k’ are less than or equal to
the corresponding elements of any other row, say row ‘r’ then row
‘k’ is dominated by the row ‘r’.
ii) If all the elements if a column, say row ‘x’ are greater than or
equal to the corresponding elements of any other column, say row
‘y’ then column ‘x’ is dominated by the column ‘y’.

Modified rule of dominance:

A given strategy can be said to be dominated of it is inferior to an average
of two or more other pure strategies. More generally,
- If convex liner combination of some rows dominates the i th row,
then i th row will be deleted, if i th row dominates the convex liner
combination of some rows, then one of the rows involved in the
convex combination may be delated.
- Similar arguments are followed for column.