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Game Theory

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

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Game Theory

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  1. Game Theory Mike ShorTopic 1 “Only the paranoid survive.” - Andy Grove, Co-founder of Intel

  2. What is Game Theory? “No man is an island, entire on itself” — John Donne, 1624 • Game theory is the study of rational behavior in interdependentsituations • A game is any situation where the outcome of your actions depends on the actions of others

  3. Games We Play

  4. Games Economists Play • Regulating collusion free-riding • Standards setting coordination • Market entry commitment • Business attraction prisoner’s dilemma • Tax compliance mixed strategies • Product announcement credibility & bluffing • Renewable resources congestion • Used goods markets information manipulation

  5. 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?

  6. 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

  7. 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

  8. federal regulatory agencies • financial firms • strategy consultancies • public policy firms • political campaigns • human resource departments • pricing divisions • intelligence agencies • the military • sports teams “Game theory is hot” — The Wall Street Journal, 13 February 1995 Students trained in game theory work for

  9. A Brief History

  10. Game Theory Administratrivia

  11. Course Information • Textbook • Not required • Course web site • Check after each lecture • Course discussion • Questions, comments

  12. Course OutlineConcepts • 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

  13. Course OutlineApplications • Winning the game • Strategic moves Credibility, threats, and promises • Information Signaling, screening, incentives • Bargaining & Auctions Participating and designing

  14. Games • Participate by 8:00 pm each Sunday • First and last game have different due date • Timed – no preparation required • Scores are known • Opponents are not • Not graded (but required) • Discuss what you did and why

  15. 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.

  16. Grading • Midterm 20 % • Final Exam 35 % • Quizzes (and Assignment) 25 % • Class Participation 10 % • Games (participation) 10 %

  17. Keys to Success • After each lecture: • Visit course web site • Do assigned readings • Do sample problems • Ask questions • Don’t fall behind

  18. Policies They have a lovely “No cell phone” policy here…

  19. Interactive Decision Theory • Decision Theory • You are goal-driven and considering your options • Game Theory • So is everyone else

  20. The Golden Rule Never assume that your opponents’ behavior is fixed. Predict their reaction to your behavior.

  21. 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

  22. Restaurant Decision-Making May I recommend that with the Bleu Cheese for ten dollars more? • Check splitting policy changes incentives. Sure! It is only a dollar more for me!

  23. Understanding Incentives • Do bicycle helmets cause fewer injuries? • Should airplanes require children to be in their own seats?

  24. Understanding Incentives • Why extra customer capacity can be bad • Can you be better off when preparing to trade with others by throwing some of your goods away? • Why cannibalize your own sales? • 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?

  25. Decision Theory • Free money! • Pick an option: • Option 1: $50 • Option 2: $40 • Option 3: $20

  26. Now What Do You Do? • Free money! • Pick an option: • Option 1: $50 or $60 • Option 2: $40 or $80 • Option 3: $20 or $90

  27. The Golden Rule Spend as much time thinking about your opponents’ strategy as you do your own.

  28. Is Game Theory Moral? ‘Game Theory’ Excuse for Anything 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) Teddy Milne October 22, 2002

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