NATIONAL LAW INSTITUTE UNIVERSITY

BHOPAL

PROJECT
on
The Game Theory

Subject: - ECONOMICS III

By :- Kumar Shashwat Submitted to:-

2010BALLB 045 Mr. C. Rajashekhar

Ass. Professor Economics

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 Contents

INTRODUCTION TO GAME THEORY .................................................... 3

Definition :- ...................................................................................... 3
Discrete Mathematics ...................................................................... 4
GAME THEORY IN CHESS .................................................................... 5
THE PRISONERS DILEMMA ................................................................. 6
A BEAUTIFUL MIND ............................................................................ 8
EXAMPLES........................................................................................... 9
Cigarette Advertising........................................................................ 9
The Battling Brewers: Miller and Budweiser .................................... 9
CONCLUSION .................................................................................... 10
BIBLIOGRAPHY .................................................................................. 11

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INTRODUCTION TO GAME THEORY
Definition :- Game theory is a branch of applied mathematics which relates to strategy
and prediction of behavior; a complicated science with a diverse range of applications.

Game theory is a branch of applied mathematics that is used in the social sciences, most
notably in economics, as well as in biology particularly evolutionary
biology and ecology, engineering, political science, international relations, computer
science, social psychology, philosophy and management.

Game theory attempts to mathematically capture behavior in strategic situations, or “games, in

which an individual's success in making choices depends on the choices of others” (Myerson,
1991). While initially developed to analyze competitions in which one individual does better at
another's expense, it has been expanded to treat a wide class of interactions, which are
classified according to several criteria. Today, "game theory is a sort of umbrella or 'unified
field' theory for the rational side of social science, where 'social' is interpreted broadly, to
include human as well as non-human players (computers, animals, plants)

Traditional applications of game theory attempt to find equilibrium in these games. In

an equilibrium, each player of the game has adopted a strategy that they are unlikely to
change. Many equilibrium concepts have been developed (E.g.: the Nash equilibrium) in an
attempt to capture this idea. These equilibrium concepts are motivated differently depending
on the field of application, although they often are similar or coincide. This methodology is not
without criticism, and debates continue over the appropriateness of particular equilibrium
concepts, the appropriateness of equilibria altogether, and the usefulness of mathematical
models more generally.

Although some developments occurred before it, the field of game theory came into being
with Émile Borel's researches in his 1938 book “Applications aux Jeux de Hasard”, and was
followed by the 1944 book “Theory of Games and Economic Behavior” by John von
Neumann and Oskar Morgenstern. It was made famous in the modern times by John Nash in
his explanation of the Nash Equilibrium later popularized in the book and movie A Beautiful
Mind.

The Game theory was envisaged as a way of making sense and ratifying the common type
random events happening in this world e.g. Stock market, migration habits etc. But presently it
finds itself at home in Economics. The use of Game Theory in predicting market trends,
analyzing company details etc. Game theorists use laws of probability to predict the decisions
the company would make and therefore which direction the market will go.

As widely known attempting to mathematically describe such volatile things as market trends
and economic conditions is a rather complicated thing and any game theorist would agree that
it is at best an imperfect science.

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Discrete Mathematics
Game theory being a part of it, Discrete mathematics is the study of mathematical structures
that are fundamentally discrete rather than continuous. In contrast to real numbers that have
the property of varying "smoothly", the objects studied in discrete mathematics – such
as integers, graphs, and statements in logic – do not vary smoothly in this way, but have
distinct, separated values. Discrete mathematics therefore excludes topics in "continuous
mathematics" such ascalculus and analysis. Discrete objects can often be enumerated by
integers. More formally, discrete mathematics has been characterized as the branch of
mathematics dealing with countable sets (sets that have the same cardinality as subsets of the
natural numbers, including rational numbers but not real numbers). However, there is no exact,
universally agreed, definition of the term "discrete mathematics." Indeed, discrete mathematics
is described less by what is included than by what is excluded: continuously varying quantities
and related notions.

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GAME THEORY IN CHESS
While when one considers the word "game," more often than not what will spring to mind is a
board game, a sport, or some other "fun" activity, when used in reference to mathematical
game theory, the word becomes much more diverse, ranging from economics and political
science to warfare, psychology, philosophy and even biology.

Game theory is, essentially, a form of mathematics which attempts to predict behavior in any
sort of "strategic" environment, whether it be the decisions made by armies on a battlefield, the
trends within a financial marketplace, essentially, a form of probabilistic mathematics, used to
determine the optimum strategy for success under certain conditions by predicting the most
probable actions of an "opponent" - or several opponents.

Consider something as seemingly simple as a game of chess. One can imagine a tree diagram
(known as a "game complexity diagram") which begins at the first player's turn, with 20
possible moves (2 for every pawn and two for each knight),

Game 1st
Starts move

Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Pawn Knight Knight Knight Knight
B1 to B2 to B3 to B4 to B5 to B6 to B7 to B8 to B1 to B2 to B3 to B4 to B5 to B6 to B7 to B8 to A2 to A2 to A7 to A7 to
C1 C2 C3 C4 C5 C6 C7 C8 D3 D2 D3 D4 D5 D6 D7 D8 C1 C3 C8 C6

branching the tree off in twenty directions. Then, for each of these twenty moves, the
opposing player also has twenty moves, meaning that each of the twenty tree branches off
another twenty times.

It has been estimated that a tree diagram for a game of chess of only 10 turns would result in a
tree diagram with almost 170 million possible branches! Furthermore, it has been said that
there are more possible games of chess of under eighty moves than there are atoms in the
universe.

And it is the job of game theory to attempt to decipher strategies in games just such as this,
and also in much more complicated games, which add in the endless complexity of human
psychology and decision making.
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THE PRISONERS DILEMMA
One way to describe a game is through an example of a very famous game called the
Prisoner's Dilemma game. Here by listing the players (or individuals) participating in the game,
and for each player, listing the alternative choices (called actions or strategies) available to that
player. In the case of a two-player game, the actions of the first player form the rows, and the
actions of the second player the columns, of a matrix. The entries in the matrix are two
numbers representing the utility or payoff to the first and second player respectively.

In this game the two players (taken A and B) are partners in a crime who have been captured
by the police. Each suspect is placed in a separate cell, and offered the opportunity to confess
to the crime. The game can be represented by the following matrix of payoffs

Not Confess Confess

B Not Confess 5,5 -4,10
Confess 10,-4 1,1

Note that higher numbers are better (more utility). If neither suspect confesses, they go free,
and split the proceeds of their crime which we represent by 5 units of utility for each suspect.
However, if one prisoner confesses and the other does not, the prisoner who confesses
testifies against the other in exchange for going free and gets the entire 10 units of utility, while
the prisoner who did not confess goes to prison and which results in the low utility of -4. If both
prisoners confess, then both are given a reduced term, but both are convicted, which we
represent by giving each 1 unit of utility: better than having the other prisoner confess, but not
so good as going free.

This game has fascinated game theorists for a variety of reasons. First, it is a simple
representation of a variety of important situations. For example, instead of confess/not confess
we could label the strategies "contribute to the common good" or "behave selfishly." This
captures a variety of situations economists describe as public goods problems. An example is
the construction of a bridge. It is best for everyone if the bridge is built, but best for each
individual if someone else builds the bridge. This is sometimes referred to in economics as an
externality. Similarly this game could describe the alternative of two firms competing in the
same market, and instead of confess/not confess we could label the strategies "set a high
price" and "set a low price." Naturally it is best for both firms if they both set high prices, but
best for each individual firm to set a low price while the opposition sets a high price.
A second feature of this game is that it is self-evident how an intelligent individual should
behave. No matter what a suspect believes his partner is going to do, it is always best to
confess. If the partner in the other cell is not confessing, it is possible to get 10 instead of 5. If
the partner in the other cell is confessing, it is possible to get 1 instead of -4. Yet the pursuit of
individually sensible behavior results in each player getting only 1 unit of utility, much less than
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the 5 units each that they would get if neither confessed. This conflict between the pursuit of
individual goals and the common good is at the heart of many game theoretic problems.
A third feature of this game is that it changes in a very significant way if the game is repeated,
or if the players will interact with each other again in the future. Suppose for example that after
this game is over, and the suspects either are freed or are released from jail they will commit
another crime and the game will be played again. In this case in the first period the suspects
may reason that they should not confess because if they do not their partner will not confess in
the second game. Strictly speaking, this conclusion is not valid, since in the second game both
suspects will confess no matter what happened in the first game. However, repetition opens up
the possibility of being rewarded or punished in the future for current behavior, and game
theorists have provided a number of theories to explain the obvious intuition that if the game is
repeated often enough, the suspects ought to cooperate.

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A BEAUTIFUL MIND
In game theory, Nash equilibrium (named after John Forbes Nash, who proposed it) is
a solution concept of a game involving two or more players, in which each player is assumed
to know the equilibrium strategies of the other players, and no player has anything to gain by
changing only his own strategy unilaterally. If each player has chosen a strategy and no player
can benefit by changing his or her strategy while the other players keep their unchanged, then
the current set of strategy choices and the corresponding payoffs constitute Nash equilibrium.

Stated simply, Amy and Phil are in Nash equilibrium if Amy is making the best decision she
can, taking into account Phil's decision, and Phil is making the best decision he can, taking into
account Amy's decision. Likewise, a group of players is in Nash equilibrium if each one is
making the best decision that he or she can, taking into account the decisions of the others.
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 businesses
forming a cartel in order to increase their profits).

At Princeton, in a series of papers published from 1950-1953, "Equilibrium Points in N-Person

Games," "Non-Cooperative Games," "The Bargaining Problem," and "Two Person Cooperative
Games," Nash outlined a new paradigm for mathematical and economic thinkers with his
pioneering use of Equilibrium Theory. He had been accepted to study in New Jersey from his
native West Virginia on a Scholarship for (Pure) Mathematics, and worked briefly under the
advising of Albert Einstein. Many of Nash's contemporaries refer to him as a (post)modern day
'genius' for his reformations to some of Adam Smith's views on Economics and when
considering his more personal characteristics, including his unorthodox teaching and research
procedures, and his past experiences with schizophrenia.
The possible theoretical limitations of equilibrium theory have led to disequilibrium neo-
Keynesian theories during the last fifty years (Hahn, Fisher). And stubborn questions remain,
even with uncertainty: what if there is more than one Nash Equilibrium in a given game; or if
the players in a game have incomplete information; or if the rationality thesis fails to clearly
convince readers who live beyond the so-called Age of Reason...? How does a unified Nash
Equilibrium maintain itself in a theoretically plural academic culture and with increasingly
complex indicators and instruments used in the scientific pursuit? Such may be the cases, for
example, when turn-of-the-century relativity theories or even practical evolutionism (i.e.
applied morphology) in Economics disallow unification on any shared equilibrium goal(s) or
value(s). But then again, this message is itself being written in a time of (post)war .

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EXAMPLES
Cigarette Advertising
Cigarette Advertising was done on TV prior to January 1, 1971. This first game answers the
question of the willingness of the cigarette manufacturers to agree to the ban. Suppose that
there are two manufacturers: Philip-Morris and Lorillard. Their profits when they advertise and
when they do not are shown in the following table:

Philip-Morris
Don't Advertise Advertise
Lorillard Don't advertise 50, 50 20, 60
Advertise 60, 20 27, 27

The Battling Brewers: Miller and Budweiser

This is an example of symmetric games and symmetric equilibria. Although we don't have
specific numbers for the payoffs in the table, they do have an ordinal ordering: d>b>0>a.

Miller
Tough Concede
Tough a, a d, 0
Budweiser
Concede 0, d b, b

The best response function for the players can be summarized as

Bud's best response to Miller Miller's best response to Bud

bBud(TMiller) = Concede bMiller(CBud) = Tough
bBud(CMiller) = Tough bMiller(TBud) = Concede

From the best response table we can see that there are two Nash equilibria. Notice that we
could switch the names of the two players and not be able to distinguish the outcome of the
new game. These are also pure strategy equilibria. If the players could coordinate their
strategies they might find it in their combined interest to both play Concede and earn a total of
2b. This would be the case if 2b>d.

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CONCLUSION
As a method of applied mathematics, game theory has been used to study a wide variety of
human and animal behaviors. It was initially developed in economics to understand a large
collection of economic behaviors, including behaviors of firms, markets, and consumers. The
use of game theory in the social sciences has expanded, and game theory has been applied to
political, sociological, and psychological behaviors as well.

Game-theoretic analysis was initially used to study animal behavior by Ronald Fisher in the
1930s (although even Charles Darwin makes a few informal game-theoretic statements). This
work predates the name "game theory", but it shares many important features with this field.
The developments in economics were later applied to biology largely by John Maynard
Smith in his book Evolution and the Theory of Games.

In addition to being used to predict and explain behavior, game theory has also been used to
attempt to develop theories of ethical or normative behavior. In economics and philosophy,
scholars have applied game theory to help in the understanding of good or proper behavior.
Game-theoretic arguments of this type can be found as far back as Plato.

The purpose of this project was to familiarize the Layman with the immensely dense and
complex concept of Game Theory and which is in use in his many day to day work and
decisions. The Concept was simplified to a great degree and many related functions of
probability and other Discrete Mathematics were not broached so as to prevent
misconceptions.

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BIBLIOGRAPHY

This project is a result of understanding and publishing of information taken

mostly from the following sources.

1. www.suite101.com
2. www.gametheory.net/lectures
3. www.iscid.org (ISCID= International Society for Complexity, Information and
Design)
4. www.dklevine.com

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