Game Theory
Mike Shor
Topic 1
“Only the paranoid survive.”
- Andy Grove, Co-founder of Intel
What is Game Theory?
“No man is an island, entire on itself”
— John Donne, 1624

Game theory is the study of rational behavior
in interdependent situations

A game is any situation where the outcome of
your actions depends on the actions of others
2
Mike Shor
Games We Play
3
Mike Shor
Games Economists Play








Collusion / OPEC
Standards setting
Market entry
Business tax breaks
free-riding
coordination
commitment
prisoner’s dilemma
Tax compliance
Product announcement
Renewable resources
Used goods markets
mixed strategies
credibility & bluffing
congestion
information manipulation
4
Mike Shor
Games
Governments play …

mixed strategies
IRS audits
Businesses play …

Employee drug testing
Sports teams play …

Run or pass? Fast ball or slider?
Defense departments play …

Where and when to attack
Politicians play …

Campaign fund expenditure
Nature plays …

Make poison or just pretend to make poison?
5
Mike Shor
Games
 Board
games, card games, video games,
sports games, computer games
 Real-life
games:
 Not
win-lose: possible for all players to win (or lose)
 Apart from the law, there is no rule book
 Others will change the game to their advantage
Success comes from playing the right game
6
Mike Shor
Why Study Game Theory?

Bad news:
Knowing game theory does not guarantee winning

Good news:
Framework for thinking about strategic interaction

Predict outcomes before the game is played

Manipulate the rules of the game (within legal and ethical
boundaries) to give yourself an advantage
7
Mike Shor
“Game theory is hot”
— The Wall Street Journal
Students trained in game theory work for





financial firms
public policy firms
strategy consultancies
federal regulatory agencies
political campaigns





human resource departments
pricing divisions
intelligence agencies
the military
sports teams
8
Mike Shor
A Brief History
9
Mike Shor
Game Theory
Administratrivia
Course Information

Textbook


Course web site


Not required
Check after each lecture
Course discussion

Questions, comments
11
Mike Shor
Course Outline
Concepts

Recognizing the game
 Simultaneous
games
Anticipating rival’s moves
 Sequential games
Looking forward – reasoning back
 Mixed strategies
Sensibility of being unpredictable
 Repeated games
Cooperation and agreeing to agree
12
Mike Shor
Course Outline
Applications

Winning the game
 Strategic
moves
Credibility, threats, and promises
 Information
Signaling, screening, incentives
 Bargaining & Auctions
Participating and designing
13
Mike Shor
Games
Participate by 6:00 pm each Sunday
 Timed – no preparation required
 Scores are known
 Opponents are not

Not graded (but required)
 Discuss what you did and why

14
Mike Shor
Quizzes & Problems

Six quizzes (best 5 count)
 No

make-ups!
Homework assignment
 Can

replace missed or lowest quiz
Extra credit
 Game
theory is everywhere. Find it.
15
Mike Shor
Grading
Midterm
 Final Exam

20 %
35 %
Quizzes (and Assignment) 25 %
 Class Participation
10 %
 Games (participation)
10 %

16
Mike Shor
Summary

After each lecture:
Visit course web site
 Do assigned readings
 Do sample problems
 Play games

Ask questions
 Don’t fall behind
 Academic integrity

17
Mike Shor
Policies
They have a lovely
“No cell phone”
policy here…
18
Mike Shor
Interactive Decision Theory

Decision Theory


You are goal-driven and considering your options
Game Theory

So is everyone else
19
Mike Shor
Decision Theory
vs. Game Theory

Ten of you go to a restaurant

If each of you pays for your own meal…
 This

is a decision problem
If you all agree to split the bill...
 Now,
this is a game
20
Mike Shor
Restaurant Decision-Making
May I recommend that with the Bleu
Cheese for ten dollars more?
Sure!
It is only
a dollar more
for me!

Check splitting policy changes incentives.
21
Mike Shor
The Golden Rule
Never assume that your opponents’
behavior is fixed.
Predict their reaction to your behavior.
22
Mike Shor
Understanding Incentives

Do bicycle helmets cause fewer injuries?

Should airplanes require children to
be in their own seats?
23
Mike Shor
Understanding Incentives

Why extra customer capacity can be bad


Why cannibalize your own sales?


Can you be better off when preparing to trade with
others by throwing some of your goods away?
Can developing a product that consumers
substitute for another of your products be good?
Where is it better to have a car break down?

Are you more likely to get someone to stop and
help on a busy street or a deserted one?
24
Mike Shor
Decision Theory
Free money!
 Pick an option:

 Option
1:
 Option 2:
 Option 3:
$50
$40
$20
25
Mike Shor
Now What Do You Do?
Free money!
 Pick an option:

 Option
1:
 Option 2:
 Option 3:
$50 or $60
$40 or $80
$20 or $90
26
Mike Shor
The Golden Rule
Spend as much time thinking about your
opponents’ strategy as you do your own.
27
Mike Shor
Game Theory & Morality
‘Game Theory’ Excuse for Anything
Teddy Milne
October 22,
2002
A student cheats on his exam. A corporation fudges its
accounts to boost its stock price. A professor lies about
his past. A politician sends out a newsletter with one
opinion to one group of constituents, another newsletter
with an opposing opinion to another group. A store
chain uses underhanded methods to gain locations. Are
these all independent actions, or part of a larger attitude
that's eating away at ethics in this country?
To me, they seem part of the ''realist'' approach to
politics, especially as exemplified by ''game theory.''
Game theory starts out by saying forget about
morality, feelings and emotions; we are going to assume
that a rational person is going to always act in his own
best interests.
In other words, self-interest is king, a theory as old as
man. Thucydides noted it in 400 B.C. Machiavelli
described it in the 16th Century, and perhaps every
generation has come up with theories, explanations and
justifications for acting selfishly.
Game theory goes on to say that you should expect
people to lie, and so you also might want to lie. Isn't this
a wonderful concept to be teaching our college students?
Here's a quote from one of the textbooks used in game
theory courses, ''Thinking Strategically,'' by Avinash
Dixit and Barry Nalebuff: ''Individuals' incentive to
cheat on any agreement should be recognized and made
a part of their strategy choice.'' In a roundabout way, this
teaches that cheating is not only acceptable, but to your
advantage.
Further, game theory suggests that in order to get a
competitive edge, you might want to pretend to be
insane, so that your opponent won't be able to judge
which way you're going to jump.
Well, we've seen that in politics, haven't we? Perhaps
Dr. Strangelove was only pretending. However, this
seems in reality a pretty insane course to take, and
might easily have unintended consequences.
(see “Mindless Commentary”, p. 3)
28
Mike Shor
Up Next…

The rules of the game

The assumptions of game theory
29
Mike Shor