Strategic Thinking & Decision Making

Session 2
Introduction to Game Theory
Strategic & Extensive Form Games 1

IIMB Strategic Thinking & Decision Making, Lecture 2 1

How should we play when our interest is

conflicted with that of the other player(s)?

IIMB Strategic Thinking & Decision Making, Lecture 2 2

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 Case: To Jail You Go.
The police have apprehended two burglars - you and me. They have also
recovered a knife from each of us. Keen to solve an old crime, they have thrown
both of us in solitary confinement. After threats and third degree methods they
have told us to confess, or go to jail.

Each of us, held separately and unable to communicate with the other, has been
given the following options.

• Anyone who confesses and implicates the other (who did not confess), will go
free while the other will get 20 years in jail.
• If neither confesses and betrays the other, the police will jail us for 1 year on the
charge of carrying a dangerous weapon.
• If both of us confess and implicate the other, each will be jailed for 10 years.

Consider your situation carefully for 5 minutes and write down what you will do.
Remember, you are being held incommunicado and can make only one choice.

Confess OR Do not confess

IIMB Strategic Thinking & Decision Making, Lecture 2 3

Case: A game of roulette.

You have been invited to play roulette. Your host has provided everyone with Rs. 100/- worth of
chips. The person who amasses the largest fortune at the end of the evening not only takes the
money home, the generous host has also promised to present two Business Class return tickets to
Hawaii.

At the last spin of the roulette wheel, you are ahead with Rs. 800/- worth of chips. The runner-up at
this stage is Roshan (or Roshni depending on your preference!) (S)he has Rs. 300/- in winnings. Other
guests are not in contention, they are content watching.

Just before the last round the runner-up offers you a deal. (S)he is willing to pool in her/his winning
with yours, give you half share and take you along to Hawaii as her/his companion. Heady with
success and a good bit of champagne you refuse. And so the last round has to be played out.

A roulette wheel has 0 to 36 numbers on it. You bet where the ball will fall when the spinning wheel
stops. The house wins when the ball lands on zero. Numbers 1 to 36 are alternately coloured red (odd
numbers) or black (even). The safest bet is pick red or black. The winning probability of 18/36 returns
Rs. 2 for Re 1 placed.

After careful deliberation Roshni / Roshan places the bet: her/his entire stake of Rs. 300 on a multiple
of three. The bet is 3:1 (on a chance of 12/36). (S)he will collect Rs.900 if (s)he wins. Now it is your turn.

Q1. What would you bet on and how much? Write down your bet.
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 Q2. If you were the runner-up, what would you
have done in the first place?

IIMB Strategic Thinking & Decision Making, Lecture 2 5

Anticipating your competitor’s behaviour is essential

to crafting strategy.

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 Game Theory
• Study of rational behaviour in interactive, interdependent situations
• Useful tool for making strategic choices. Does not guarantee winning.
• Robust framework for strategic thinking
– Assumes human being is a rational agent
• Utility maximisation is agent’s principal objective
• Also considers extended, subjective rationality (sessions 7, 8)
• Study of conflict and co-operative games
• Can be helpful to formulate strategies for competitive advantage
– In conflict and competitive situations
– In co-operative games

IIMB Strategic Thinking & Decision Making, Lecture 2 7

What is a game?
• Characteristics of a game
– Players
– Strategies
– Payoffs
– Information
• Perfect: rules, strategies, and outcomes are known to all and
each knows that others know
• Imperfect: information is probabilistic, or partly known to
either or both players
• Games of conflict or co-operation

IIMB Strategic Thinking & Decision Making, Lecture 2 8

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 Types of games
1. Simultaneous (Strategic Form)
– Players act without knowledge of opponent’s move
2. Sequential (Extensive Form)
– Observe other player’s move before making your own move
3. Combination: Simultaneous games played sequentially
4. What types of games are these?
– 4X100 metre relay race: simultaneous or sequential?
– Formula 1 motor racing?
– Voting by secret ballot? Voting by show of hands?
– Combination game…..?
IIMB Strategic Thinking & Decision Making, Lecture 2 9

Extensive Form Games (Sequential)

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 Roulette game tree

R can see s/he cannot win if Roshni/Roshan Player 2 can see that any bet other
her/his bet is 1:2 or less. It has to than what R has placed cannot
be 1:3 or higher. assure victory.
300 on Black 300 on multiple of 3

Player 2 300 on Black Player 2

300 on Black 800 on multiple of
300 on multiple of 3
3

[36]
[Black] [Red] 900, 1100 [33]
600, 1100 0, 500 900, 500

[24] [22] [24] [22]

600, 2400 600, 0 900, 1400 0, 500

IIMB Strategic Thinking & Decision Making, Lecture 2 11

Rollback Reasoning
• Rule: Look forward and reason back
– Players should be able to observe earlier moves
– Moves once made cannot be reversed

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 Sharing game
• Dad buys Ram a scoop of ice cream and tells him to share
with brother Shyam. How much of it should Ram give
Shyam?
• Since there is no loss, they can continue to negotiate and
argue forever.
• Let’s assume a finite cost of time…..
– How much should Ram offer Shyam if the ice-cream
melts by half scoop each time an offer is made and
refused?
• 1½0
IIMB Strategic Thinking & Decision Making, Lecture 2 13

Bargaining
Ram: 1 scoop
50:50 Keep all
Shyam Shyam
Accepts
Rejects Rejects
Shyam ½ scoop Shyam ½ scoop
½:½ 50:50 Keep all
50:50 Keep all
Ram Ram Ram Ram

Accepts Rejects Accepts Accepts Rejects

Rejects Accepts

¼:¼ 0:0 0:0

0: ½ ¼:¼ 0: ½ 0:0

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 How much should Ram offer Shyam if the ice-
cream melts by 1/3rd scoop each time an offer is
made and refused?
1  2/3  1/3  0

IIMB Strategic Thinking & Decision Making, Lecture 2 15

Ice-cream melts 1/3rd each time an offer is refused

Sense of fairness?
Cost of time?
Ram: 1 scoop
50:50 R2/3 : S1/3
Shyam Keep all Accepts
Accepts Shyam 2/3 : 1/3
Rejects Shyam
Rejects Rejects
Shyam 2/3 scoop 2/3 scoop
2/3 scoop Shyam
½:½ 50:50 Keep all S Keep
all 50:50
R1/3: S2/3
Ram Ram R Rejects Ram Ram
1/3 scoop Rejects
Accepts Rejects Accepts Accepts Accepts
R Keep all

0 : 2/3 1/3 scoop

1/3 : 1/3 1/3 scoop 1/3 : 1/3 1/3 scoop 2/9 : 4/9
1/3 : 0

How should sharing change if ice cream melts 1/2, 1/4th, 1/5th, 1/6th, 1/7th?
IIMB Strategic Thinking & Decision Making, Lecture 2 16

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 Strategic Form (Simultaneous) Game

Prisoners’ dilemma

IIMB Strategic Thinking & Decision Making, Lecture 2 17

Representing Prisoners’ Dilemma

Jerry
Confess Don’t

Confess 10, 10 0, 20

Tom
Don’t 20, 0 1, 1

What should Tom do? And Jerry?

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 Tom’s Payoff Matrix

Confess 10 0

Don’t 20 1

UT (c, d)= 0; UT (c, c)= 10; UT (d, c)= 20; UT (d, d)= 1

IIMB Strategic Thinking & Decision Making, Lecture 2 19

Jerry’s Payoff Matrix

Jerry
Confess Don’t

10 20

0 1

UJ (c, d)= 0; UJ (c, c)= 10; UJ (d, c)= 20; UJ (d, d)= 1
What should Jerry do?
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 Prisoners’ Dilemma Equilibrium
Jerry
Confess Don’t

Confess 10, 10 0, 20

Tom
Don’t 20, 0 1, 1

IIMB Strategic Thinking & Decision Making, Lecture 2 21

Dominant Strategy
If the same strategy is chosen for each of the different
combinations of strategies a player might face, that
strategy is called a "dominant strategy" for that player in
that game.

How many types of dominant strategies can there be?

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 Dominant strategies….1 ?
Player B
X Y

P 15, 5 10, 8

Player A
Q 12, 0 4, 1

Strict dominance!
IIMB Strategic Thinking & Decision Making, Lecture 2 23

Dominant strategies….2 ?
Player B
X Y

P 15, 5 10, 8

Player A
Q 12, 1 4, 1

A  P is strictly dominant. B  Y is weakly dominant.

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 If a player has a dominant strategy among
other strategies, what should they do?

Why?

IIMB Strategic Thinking & Decision Making, Lecture 2 25

What is rationality?
When are we rational?

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 Equilibrium
Equilibrium is a stable solution: a state from which neither
player has any reason to move.

IIMB Strategic Thinking & Decision Making, Lecture 2 27

Dominant strategy equilibrium

If each player has a dominant strategy, and each plays the
dominant strategy, then that combination of (dominant)
strategies and the corresponding payoffs are said to
constitute the dominant strategy equilibrium for that game.

RULE:
In Strategic Form games if you have a dominant strategy, use
it regardless of what the other player uses.

Dominant strategy equilibrium is a special class of equilibrium.

IIMB Strategic Thinking & Decision Making, Lecture 2 28

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 Signature characteristics of PD?

• Simultaneous game
– Players cannot communicate with each other
• Both parties have their dominant strategies
• Playing their dominant (best) strategies makes
them worse off than they expected

IIMB Strategic Thinking & Decision Making, Lecture 2 29

Issues – Prisoners’ Dilemma

• Does it explain actual experience? Rationality?
– India-Pakistan nuclear weapon race / Cold War post WW 2
– Traffic jam on Bangalore roads
– Female foeticide and infanticide
• Does it reflect interaction among > 2?
– Paying for a new elevator in a low-rise apartment
• What would happen if the game was repeated many
times?
• What if they could communicate with each other?

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 Caution
• Outcome of a dominant strategy is not the best
possible outcome
• The worst result of dominant strategy is not better
than the best outcome of any other strategy
• Dominant strategy applies to simultaneous as
well as sequential games
• It doesn’t always exist!

IIMB Strategic Thinking & Decision Making, Lecture 2 31

Why these esoteric concepts?

• Recognise situations you may find yourself in. Craft
effective strategies / responses for them.
• Create / shape situations to your advantage
– Bidding / tender system design
– Negotiations
• Other applications…
– Solving civic problems (Traffic jams)
– International trade negotiations
– Building a new seaport, container terminal
– Others….
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 Strategies for games?
• Game Theory …. Under Perfect Information
– Players, their strategies, payoffs, and rules
– Games of finite, known duration, iteration
– Especially in games of conflict
• A methodology for strategic thinking

IIMB Strategic Thinking & Decision Making, Lecture 2 33

“My secret is practice.”

David Beckham

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 Traffic Jam – payoff in minutes

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