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Understanding Game Theory: Strategic Behavior and Applications

Explore game theory models where agents' decisions impact others, applicable in oligopolies, cartels, externalities, and military strategies. Learn two-player games, payoff matrices, Nash equilibrium, and the Prisoner's Dilemma illustrating strategic decision-making.

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Understanding Game Theory: Strategic Behavior and Applications

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  1. Chapter Twenty-Eight Game Theory

  2. Game Theory • Game theory models strategic behavior by agents who understand that their actions affect the actions of other agents.

  3. Some Applications of Game Theory • The study of oligopolies (industries containing only a few firms) • The study of cartels; e.g. OPEC • The study of externalities; e.g. using a common resource such as a fishery. • The study of military strategies.

  4. What is a Game? • A game consists of • a set of players • a set of strategies for each player • the payoffs to each player for every possible list of strategy choices by the players.

  5. Two-Player Games • A game with just two players is a two-player game. • We will study only games in which there are two players, each of whom can choose between only two strategies.

  6. An Example of a Two-Player Game • The players are called A and B. • Player A has two strategies, called “Up” and “Down”. • Player B has two strategies, called “Left” and “Right”. • The table showing the payoffs to both players for each of the four possible strategy combinations is the game’s payoff matrix.

  7. An Example of a Two-Player Game L R (3,9) (1,8) U (0,0) (2,1) D Player B This is thegame’s payoff matrix. Player A Player A’s payoff is shown first.Player B’s payoff is shown second.

  8. An Example of a Two-Player Game Player B L R This is thegame’s payoff matrix. (1,8) (3,9) U Player A (0,0) (2,1) D E.g. if A plays Up and B plays Right then A’s payoff is 1 and B’s payoff is 8.

  9. An Example of a Two-Player Game Player B L R This is thegame’s payoff matrix. (3,9) (1,8) U Player A (2,1) (0,0) D And if A plays Down and B plays Right then A’s payoff is 2 and B’s payoff is 1.

  10. An Example of a Two-Player Game L R (3,9) (1,8) U (0,0) (2,1) D Player B Player A A play of the game is a pair such as (U,R) where the 1st element is the strategy chosen by Player A and the 2nd is the strategy chosen by Player B.

  11. An Example of a Two-Player Game L R (3,9) (1,8) U (0,0) (2,1) D Player B Player A What plays are we likely to see for this game?

  12. An Example of a Two-Player Game Player B L R Is (U,R) alikely play? (1,8) (3,9) U Player A (0,0) (2,1) D

  13. An Example of a Two-Player Game Player B L R Is (U,R) alikely play? (1,8) (3,9) U Player A (0,0) (2,1) D If B plays Right then A’s best reply is Downsince this improves A’s payoff from 1 to 2.So (U,R) is not a likely play.

  14. An Example of a Two-Player Game Player B L R Is (D,R) alikely play? (3,9) (1,8) U Player A (2,1) (0,0) D

  15. An Example of a Two-Player Game Player B L R Is (D,R) alikely play? (3,9) (1,8) U Player A (2,1) (0,0) D If B plays Right then A’s best reply is Down.

  16. An Example of a Two-Player Game Player B L R Is (D,R) alikely play? (3,9) (1,8) U Player A (2,1) (0,0) D If B plays Right then A’s best reply is Down. If A plays Down then B’s best reply is Right. So (D,R) is a likely play.

  17. An Example of a Two-Player Game Player B L R Is (D,L) alikely play? (3,9) (1,8) U Player A (0,0) (2,1) D

  18. An Example of a Two-Player Game Player B L R Is (D,L) alikely play? (3,9) (1,8) U Player A (0,0) (2,1) D If A plays Down then B’s best reply is Right,so (D,L) is not a likely play.

  19. An Example of a Two-Player Game Player B L R Is (U,L) alikely play? (3,9) (1,8) U Player A (0,0) (2,1) D

  20. An Example of a Two-Player Game Player B L R Is (U,L) alikely play? (3,9) (1,8) U Player A (0,0) (2,1) D If A plays Up then B’s best reply is Left.

  21. An Example of a Two-Player Game Player B L R Is (U,L) alikely play? (3,9) (1,8) U Player A (0,0) (2,1) D If A plays Up then B’s best reply is Left. If B plays Left then A’s best reply is Up. So (U,L) is a likely play.

  22. Nash Equilibrium • A play of the game where each strategy is a best reply to the other is a Nash equilibrium. • Our example has two Nash equilibria; (U,L) and (D,R).

  23. An Example of a Two-Player Game Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D (U,L) and (D,R) are both Nash equilibria forthe game.

  24. An Example of a Two-Player Game Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D (U,L) and (D,R) are both Nash equilibria forthe game. But which will we see? Noticethat (U,L) is preferred to (D,R) by bothplayers. Must we then see (U,L) only?

  25. The Prisoner’s Dilemma • To see if Pareto-preferred outcomes must be what we see in the play of a game, consider a famous second example of a two-player game called the Prisoner’s Dilemma.

  26. The Prisoner’s Dilemma Clyde S C (-5,-5) (-30,-1) S Bonnie (-1,-30) (-10,-10) C What plays are we likely to see for this game?

  27. The Prisoner’s Dilemma Clyde S C (-5,-5) (-30,-1) S Bonnie (-1,-30) (-10,-10) C If Bonnie plays Silence then Clyde’s bestreply is Confess.

  28. The Prisoner’s Dilemma Clyde S C (-5,-5) (-30,-1) S Bonnie (-1,-30) (-10,-10) C If Bonnie plays Silence then Clyde’s bestreply is Confess. If Bonnie plays Confess then Clyde’sbest reply is Confess.

  29. The Prisoner’s Dilemma Clyde S C (-5,-5) (-30,-1) S Bonnie (-1,-30) (-10,-10) C So no matter what Bonnie plays, Clyde’sbest reply is always Confess. Confess is a dominant strategy for Clyde.

  30. The Prisoner’s Dilemma Clyde S C (-5,-5) (-30,-1) S Bonnie (-1,-30) (-10,-10) C Similarly, no matter what Clyde plays,Bonnie’s best reply is always Confess. Confess is a dominant strategy forBonnie also.

  31. The Prisoner’s Dilemma Clyde S C (-5,-5) (-30,-1) S Bonnie (-1,-30) (-10,-10) C So the only Nash equilibrium for thisgame is (C,C), even though (S,S) givesboth Bonnie and Clyde better payoffs. The only Nash equilibrium is inefficient.

  32. Who Plays When? • In both examples the players chose their strategies simultaneously. • Such games are simultaneous play games.

  33. Who Plays When? • But there are games in which one player plays before another player. • Such games are sequential play games. • The player who plays first is the leader. The player who plays second is the follower.

  34. A Sequential Game Example • Sometimes a game has more than one Nash equilibrium and it is hard to say which is more likely to occur. • When such a game is sequential it is sometimes possible to argue that one of the Nash equilibria is more likely to occur than the other.

  35. A Sequential Game Example Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D (U,L) and (D,R) are both Nash equilibriawhen this game is played simultaneouslyand we have no way of deciding whichequilibrium is more likely to occur.

  36. A Sequential Game Example Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D Suppose instead that the game is playedsequentially, with A leading and B following. We can rewrite the game in its extensive form.

  37. A Sequential Game Example A U D A plays first.B plays second. B B L R L R (0,0) (2,1) (1,8) (3,9)

  38. A Sequential Game Example A U D A plays first.B plays second. B B L R L R (0,0) (2,1) (1,8) (3,9) (U,L) is a Nash equilibrium.

  39. A Sequential Game Example A U D A plays first.B plays second. B B L R L R (0,0) (2,1) (1,8) (3,9) (U,L) is a Nash equilibrium. (D,R) is a Nash equilibrium.Which is more likely to occur?

  40. A Sequential Game Example A U D A plays first.B plays second. B B L R L R (0,0) (2,1) (1,8) (3,9) If A plays U then B plays L; A gets 3.

  41. A Sequential Game Example A U D A plays first.B plays second. B B L R L R (0,0) (2,1) (1,8) (3,9) If A plays U then B plays L; A gets 3. If A plays D then B plays R; A gets 2.

  42. A Sequential Game Example A U D A plays first.B plays second. B B L R L R (0,0) (2,1) (1,8) (3,9) If A plays U then B plays L; A gets 3. If A plays D then B plays R; A gets 2.So (U,L) is the likely Nash equilibrium.

  43. Pure Strategies Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D This is our original example once more.Suppose again that play is simultaneous.We discovered that the game has two Nashequilibria; (U,L) and (D,R).

  44. Pure Strategies Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D Player A’s has been thought of as choosingto play either U or D, but no combination ofboth; that is, as playing purely U or D.U and D are Player A’s pure strategies.

  45. Pure Strategies Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D Similarly, L and R are Player B’s purestrategies.

  46. Pure Strategies Player B L R (3,9) (1,8) U Player A (2,1) (0,0) D Consequently, (U,L) and (D,R) are purestrategy Nash equilibria. Must every gamehave at least one pure strategy Nashequilibrium?

  47. Pure Strategies Player B L R (1,2) (0,4) U Player A (0,5) (3,2) D Here is a new game. Are there any purestrategy Nash equilibria?

  48. Pure Strategies Player B L R (1,2) (0,4) U Player A (0,5) (3,2) D Is (U,L) a Nash equilibrium?

  49. Pure Strategies Player B L R (0,4) (1,2) U Player A (0,5) (3,2) D Is (U,L) a Nash equilibrium? No. Is (U,R) a Nash equilibrium?

  50. Pure Strategies Player B L R (1,2) (0,4) U Player A (0,5) (3,2) D Is (U,L) a Nash equilibrium? No. Is (U,R) a Nash equilibrium? No.Is (D,L) a Nash equilibrium?

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