2. The bird flu epidemic is expected to hit your
town and it is estimated that 600 people will die.
Which of following two drugs, A or B will you
recommend to combat the epidemic given the
following information?
If Drug A is used: 200 will be saved
If Drug B is used: 1/3 chance that all 600 will be
saved and 2/3 chance that nobody will be saved.
3. The bird flu epidemic is expected to hit your
town and it is estimated that 600 people will die.
Which of following two drugs, C or D will you
recommend to combat the epidemic given the
following information?
If Drug C is used: 400 will die
If Drug D is used: 1/3 chance that nobody will
die, and 2/3 chance that 600 will die.
4. Three Elements of a Game
1)The players
how many players are there?
does nature/chance play a role?
2) A complete description of the strategies of each player
3) A description of the consequences (payoffs) for each
player for every possible profile of strategy choices of all
players.
5. Why Game theory?
Managers make decisions on pricing & output
Based on their anticipation or reaction to the decisions
made by their competitors.
The kinked demand model:
Explains : Why prices in such markets tend to be very
similar
But does not explain : how & why this price is
established in the first place
Game theory – helps in understanding these decisions
6. Game theory
“How individuals make decisions - when they are aware that
their actions effect each other & when each individual takes
this into account”
The perquisites:
Interdependence
Your decisions effect others & their decisions effect you
Uncertainty
You don’t know what decisions will they take nor do
they know what decisions will you take
7. STRATEGY
In Oilgopolistic market situation
The problem is to choose a rational course of action –
Strategy.
A Strategy is a course of action or policy which player or
participant in a game will adopt during the play of the game.
The various alternative strategies are:
1) Changing the price
2) Changing the level of output
3) Increasing advertisement expenditure
4) Varying the product
8. A firm behaves strategically, that is while taking its decision regarding
price, output, advertising it takes into account how its rivals firms will
react assuming them to be rational i.e they will do there best to promote
their interest while making decisions.
Kinds of Games:
Cooperative Games:
A binding contract that permits them to adopt a strategy to
maximise joint profits.
Non- Cooperative Games:
Competing firm take each other actions into account but they take
decisions independently and adopt strategies.
9. Dominant Strategy
A Strategy which will be successful or optimal for a firm
regardless of what others do, i.e no matter what the strategy the
rival firm adopts.
For example:
Two companies A & B
Firms need to promote its sales and profits
Strategy for them is to Advertise or Not Advertise
10. DOMINANT STRATEGY
Pay- Off Matrix for Advertising Games
Dominant Strategy
In Rs Crores
Firm B
Advertise
Not Advertise
Dominant
Strategy
F
I
r
m
A
Advertise
Not
Advertise
0
5
15
10
2
8
6
10
11. DOMINANT STRATEGY
Pay- Off Matrix for Advertising Games
Firm A: Choice of advertising is optimal for it irrespective whatever
decision firm B makes
Firm B: Choice of advertising is optimal for it irrespective whatever
decision firm A makes
Since it is assumed that both firms behave rationally each of them will
choose the strategy of Advertising and the outcome will be profits of Rs
10 cr for firm A and Rs 5 cr for firm B
12. Absence of Dominant Strategy
Pay- Off Matrix for Advertising Games
In Rs Crores
Firm B
Advertise
Not Advertise
F
I
r
m
A
Advertise
Not
Advertise
0
5
15
10
2
8
6
20
13. Absence of Dominant Strategy
Optimal strategy for Firm A depends on which strategy the firm B
adopts.
“Advertising” strategy is optimal for firm A, given that firm B adopts the
same.
Non- Advertising by firm A is better given that firm B adopts the same.
Thus there is no Dominant strategy existing
But how does firm make an optimal decision regarding choice of
strategy if both the firm choose their strategies simultaneously.
14. Choice of an Optimal strategy in
the absence of a Dominant
Strategy.
Both the firm must put itself in other firms place
and then decide.
If firm A choosers strategy of Advertising the firm
B will make profit of 5 cr
15. Nash’s Equilibrium
Nash equilibrium (named after John Forbes Nash) is a
solution concept of a game involving two or more players.
Each player is assumed to know the equilibrium strategies
of the other players, and no player has anything to gain by
changing only his or her own strategy (i.e., by changing
unilaterally).
If each player has chosen a strategy and no player can
benefit by changing the strategy while the other players
keep theirs unchanged, then the current set of strategy
choices and the corresponding payoffs constitute a Nash
equilibrium.
16. Nash’s Equilibrium
In a Nash equilibrium, each player must respond
negatively to the question: "Knowing the strategies of the
other players, and treating the strategies of the other
players as set in stone, can I benefit by changing my
strategy?“
However, Nash equilibrium does not necessarily mean the
best cumulative payoff for all the players involved; in many
cases all the players might improve their payoffs if they
could somehow agree on strategies different from the
Nash equilibrium (e.g. competing businessmen forming a
cartel in order to increase their profits).
17. In Dominant strategy equilibrium describes an
optimal or best choice regardless of what
strategy the other player adopts
Whereas
In Nash each player adopts a strategy that is
best or optimal for him given the strategy of the
other player
19. Prisoner’s Dilemma
In this model the decision of each prisoner in favour of
confession is quite rational because each person works
in self- interest and tries to make the best of the worst
outcome in an uncertain situation.
Prisoners
Dilemma can never be resolved if you
approach the problem from outside, that is from the
other’s viewpoint first.
The problem offers a resolution only if you approach the
problem from inside, that is , from your own self.
20. Prisoner’s Dilemma
The only way to resolve the dilemma is to ask,
“Whats the right course of action that could be
best for BOTH”.
If you look inward, no matter how selfish you are,
you will find the correct resolution to the dilemma.
23. In the context of companies
In Rs Lakhs
COMPANY 1
Cheat
C
Cheat
O
M
PA
N
Y Cooperate
2
Cooperate
2
5
25
5
15
25
2
15
Equilibrium State
24. In the context of companies
If both the firm cooperate and abide by cartel they share
huge amount of profits.
Each firm has strong incentive to cheat
It’s the pursuit of self- interest rather than common
interest that prompts the firms to cheat each other.
Thus if both the firm cheat they will break down the
cartel.
25. Steal v/s Split
Player 1
Split
P
L
A
Y
E
R
2
Split
Steal
100150
50075
0
50075
0
Steal
100150
In $
0
0
If it’s a one time game then a the chances of steal are high but a
repeated game would make the players split.
26. Game Theory Rules
You should choose your strategy on the
assumption that your opponent will act in
his best interest
27. Repeated Games & Tit- for Tat
Strategy
The Games so far are played just once, so they can
cheat.
However in case of repeated games the oligopolist may
adopt a cooperative behaviour which enables them to
earn large profits
In repeated game one firm has the the opportunity to
penalise the other for his previous bad behaviour – Tit
for TAT Strategy
28. Nash’s Equilibrium
PEPSI
High Price
Low Price
C
O
K
E
High
Price
Low
Price
200
200
150
20
20
150
50
50
Firms will form a cartel and go for high price than cheating on one another
