Subject Name:

OPERATIONS RESEARCH
Subject Code:
10CS661
Prepared By:
Sindhuja K
Department:
CSE

05/19/20
 UNIT VII-
Game Theory, Decision Analysis

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 Objective

• Competition in business, military operations,

advertising about a product , marketing etc.,
• It is essential to guess the activities or actions
of his opponent or competitor.

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 Game Theory

• Game theory is a mathematical theory that deals with

the general features of competitive situations like
these in a formal, abstract way. It places particular
emphasis on the decision-making processes.
• Game theory is a decision theory in where ones
choice of action is determined after talking into
account all possible alternatives available to an
opponent playing in a same field.

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 Basic Terms used in game theory

• Player –Competitor(individual or group or

organization)
• Strategy – Alternate course of action(choices)
• Pure strategy – Using same strategy each time
(deterministic)
• Mixed strategy – Using the course of action depending
on some fixed probability.
• Optimum strategy – The choice that puts the player in
the most preferred position irrespective of his
competitors strategy.
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 Two person zero – sum game
• Definition: Only 2 persons are involved in the game and the
gain made by one player is equal to the loss of the other.
• As the name implies, these games involve only two players
.They are called zero-sum games because one player wins
whatever the other one loses, so that the sum of their net
winnings is zero.
• In general, a two-person game is characterized by
The strategies of player 1.
The strategies of player 2.
The pay-off table.

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 Two person zero – sum game

• Terms used
– Pay off matrix: The representation of gains and
losses resulting from different actions of the
competitors is represented in the form of a matrix.
– Value of game: It is the expected outcome of the
player when all the players of the game follow
their optimum strategy.
– Fair game: Value of the game is zero.

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 Formulation of Two person zero – sum
game
B1 B2 ……… Bn
A1 a11 a12 ……… a1n
A2 a21 a22 …........ a2n
. .
. .
Am am1 am2 ………. amn
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 Formulation of Two person zero – sum
game
• A1,A2,…..,Am are the strategies of
player A
• B1,B2,…...,Bn are the strategies of
player B
• aij is the payoff to player A (by B) when
the player A plays strategy Ai and B plays
Bj (aij is –ve means B got |aij| from A)

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 Example
Consider the game of the odds and evens. This game consists of two
players A,B, each player simultaneously showing either of one finger or
two fingers. If the number of fingers matches, so that the total number for
both players is even, then the player taking evens (say A) wins Rs.1 from
B (the player taking odds). Else, if the number does not match, A pays
Rs.1 to B. Thus the payoff matrix to player A is the following table:

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 Optimum Solution
• A game can be solved by using the following three methods,
based on the nature of the problem.
– Saddle point concept/Max-min and Min max principle
• Games without saddle point

– Dominance rule
– Graphical method.

• A primary objective of game theory is the development of rational

criteria for selecting a strategy. Two key assumptions are made:
– Both players are rational
– Both players choose their strategies solely to promote their own welfare

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 Min- Max and Max-Min principle
• Max –Min : A row(winning) payer will select the maximum
out of the minimum gains.

• Min- Max : A column(loosing) player will always try to

minimize his maximum losses.

• Saddle point: If the max-min and min-max values are same

then the game has a saddle point and is the intersection point
of both the values.

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 B1 B2 B3 B4 Row min
A1 8 6 2 8 2
A2 8 9 4 (SP) 5 4
7 5 3 5 3
A3

Col 8 9 4 8 max min

Max
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 Solution
• The solution of the game is based on the principle of securing
the best of the worst for each player. If the player A plays
strategy 1, then whatever strategy B plays, A will get at least
2.
• Similarly, if A plays strategy 2, then whatever B plays, will
get at least 4. and if A plays strategy 3, then he will get at least
3 whatever B plays.
• Thus to maximize his minimum returns, he should play
strategy 2.

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 Solution (cont..)
• Now if B plays strategy 1, then whatever A plays, he will lose
a maximum of 8. Similarly for strategies 2,3,4. (These are the
maximum of the respective columns). Thus to minimize this
maximum loss, B should play strategy 3.
• and 4 = max (row minima)
• = min (column maxima)
• is called the value of the game.
• 4 is called the saddle-point.

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 Dominance Rule
• Definition: A strategy is dominated by a second strategy if
the second strategy is always at least as good (and sometimes
better) regardless of what the opponent does. Such a
dominated strategy can be eliminated from further
consideration.
• The following rules of dominance is used reduce the sixe of
the matrix
– Row dominance
– Column dominance
– Modified row dominance- Average of rows
– Modified column dominance- Average of columns

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 Example
• Thus in our example (below), for player A, strategy A3 is dominated by
the strategy A2 and so can be eliminated.
• Eliminating the strategy A3 , we get the
B1 B2 B3 B4
A1 8 6 2 8
A2 8 9 4 5
7 5 3 5
A3

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 Cont..
• following reduced payoff matrix:
• Now , for player B, strategies B1, B2, and B4 are dominated by the
strategy B3.
• Eliminating the strategies B1 , B2, and B4 we get the reduced payoff
matrix:

B1 B2 B3 B4
A1 8 6 2 8
A2 8 9 4 5

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 Cont..
• following reduced payoff matrix:
• Now , for player A, strategy A1 is dominated by the strategy A2.
• Eliminating the strategy A1 we thus see that A should always play A2 and B
always B3 and the value of the game is 4 as before.

B3
A1 2

A2
4

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 Example
The following game gives A’s payoff. Determine p,q that
will make the entry (2,2) a saddle point.

B1 B2 B3
Row min
A1 1 q 6
min(1,q)
A2 p 5 10
min(p,5)
A3 6 2 3
2
Col max max(p,6) max(q,5) 10
Since (2,2) must be a saddle point,
p5
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q5 20
 Example
Specify the range for the value of the game in the following case
assuming that the payoff is for player A.
B1 B2 B3 Row min
A1 3 6 1 1

A2 5 2 3 2

A3 4 2 -5 -5

Col max 5 6 3
Thus max( row min) <= min (column max)
The game has no saddle point. Thus the value of the game lies between 2 and 3.

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 Games without saddle point(mixed
strategy)
• No pure strategy or no saddle point exists.
• The optimal mix for each player may be determined by
assigning each strategy a probability of it being chosen.
Thus these mixed strategies are probabilistic combinations
of available better strategies and these games hence called
Probabilistic games.  
• The probabilistic mixed strategy games without saddle points
are commonly solved by any of the following methods
– Analytical Method
– Graphical Method
– Simplex Method

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 Analytical Method
• A 2x2 game without saddle point can be solved using following formula.

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 Formula

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 Example
• Solve the following game and determine its value

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 Graphical Method : Solution of 2 x n and
m x 2 Games
• 2 x n and m x 2 Games : When the player A, for example, has
only 2 strategies to choose from and the player B has n, the
game shall be of the order 2 x n, whereas in case B has only
two strategies available to him and A has m strategies, the
game shall be a m x 2 game.

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 Example
• Solve the following using graphical method.

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 Algorithm for solving 2 x n matrix games
• Draw two vertical axes 1 unit apart. The two lines are x1 = 0, x1 =
1
• Take the points of the first row in the payoff matrix on the
vertical line x1 = 1 and the points of the second row in the
payoff matrix on the vertical line x1 = 0.
• The point a1j on axis x1 = 1 is then joined to the point a2j
on the axis x1 = 0 to give a straight line. Draw ‘n’ straight
lines for j=1, 2… n and determine the highest point of the lower
envelope obtained. This will be the maximin point.
• The two or more lines passing through the maximin point
determines the required 2 x 2 payoff matrix. This in turn gives
the optimum solution by making use of analytical method.

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 Example
• Solve using graphical method

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 Solution

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 Cont..

• V = 66/13
• SA = (4/13, 9 /13)
• SB = (0, 10/13, 3 /13

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 Algorithm for solving m x 2 matrix games
• Draw two vertical axes 1 unit apart. The two lines are x1 =0, x1 =
1
• Take the points of the first row in the payoff matrix on the
vertical line x1 = 1 and the points of the second row in the
payoff matrix on the vertical line x1 = 0.
• The point a1j on axis x1 = 1 is then joined to the point a2j
on the axis x1 = 0 to give a straight line. Draw ‘n’ straight
lines for j=1, 2… n and determine the lowest point of the upper
envelope obtained. This will be the minimax point.
• The two or more lines passing through the minimax point
determines the required 2 x 2 payoff matrix. This in turn gives
the optimum solution by making use of analytical method.

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 Example

• Solve by graphical method

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 Solution

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 Cont..

• V = 3/9 = 1/3
• SA = (0, 5 /9, 4/9, 0)
• SB = (3/9, 6 /9)
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 Decision Analysis

• Decision making without experimentation

• Decision making criteria
• Decision making with experimentation
• Expected value of experimentation
• Decision trees
• Utility theory

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 Decision Making without Experimentation
• Goferbroke Company owns a tract of land that may contain oil
• Consulting geologist: “1 chance in 4 of oil”
• Offer for purchase from another company: $90k
• Can also hold the land and drill for oil with cost $100k
• If oil, expected revenue $800k, if not, nothing
Payoff
Alternative Oil Dry
Drill for oil
Sell the land
Chance 1 in 4 3 in 4

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 Notation and Terminology
• Actions: {a1, a2, …}
– The set of actions the decision maker must choose from
– Example:

• States of nature: {1, 2, ...}

– Possible outcomes of the uncertain event.
– Example:

• Payoff/Loss Function: L(ai, k)

– The payoff/loss incurred by taking action ai when state k occurs.
– Example:

• Prior distribution:
– Distribution representing the relative likelihood of the possible states of nature.

• Prior probabilities: P( = k)

– Probabilities (provided by prior distribution) for various states of nature.
– Example:

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 Decision Making Criteria

• Can “optimize” the decision with respect to

several criteria

– Maximin payoff
– Minimax regret
– Maximum likelihood
– Bayes’ decision rule (expected value)

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 Maximin Payoff Criterion
• For each action, find minimum payoff over all states of nature
• Then choose the action with the maximum of these minimum payoffs

State of Nature
Min
Action Oil Dry
Payoff

Drill for oil 700 -100

Sell the land 90 90

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 Minimax Regret Criterion
• For each action, find maximum regret over all states of nature
• Then choose the action with the minimum of these maximum regrets

(Payoffs) State of Nature

Action Oil Dry
Drill for oil 700 -100
Sell the land 90 90

(Regrets) State of Nature

Max
Action Oil Dry
Regret

Drill for oil

Sell the land
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 Maximum Likelihood Criterion
• Identify the most likely state of nature
• Then choose the action with the maximum payoff under that state of nature

State of Nature
Action Oil Dry
Drill for oil 700 -100
Sell the land 90 90
Prior probability 0.25 0.75

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 Bayes’ Decision Rule
(Expected Value Criterion)
• For each action, find expectation of payoff over all states of nature
• Then choose the action with the maximum of these expected payoffs

State of Nature
Expected
Action Oil Dry
Payoff

Drill for oil 700 -100

Sell the land 90 90
Prior probability 0.25 0.75

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 Sensitivity Analysis with
Bayes’ Decision Rule
• What is the minimum probability of oil such that we choose to drill the
land under Bayes’ decision rule?

State of Nature
Expected
Action Oil Dry
Payoff

Drill for oil 700 -100

Sell the land 90 90
Prior probability p 1-p

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 Decision Making with Experimentation
State of Nature
Action Oil Dry
Drill for oil 700 -100
Sell the land 90 90
Prior probability 0.25 0.75

• Option available to conduct a detailed seismic survey to obtain a better

estimate of oil probability
• Costs $30k
• Possible findings:
– Unfavorable seismic soundings (USS), oil is fairly unlikely
– Favorable seismic soundings (FSS), oil is fairly likely

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 Posterior Probabilities
• Do experiments to get better information and improve estimates for the
probabilities of states of nature. These improved estimates are called
posterior probabilities.
• Experimental Outcomes: {x1, x2, …}

Example:

• Cost of experiment: 

Example:
• Posterior Distribution: P( = k | X = xj)

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 Goferbroke Example (cont’d)
• Based on past experience:
• If there is oil, then
• the probability that seismic survey findings is USS = 0.4 =
P(USS | oil)
• the probability that seismic survey findings is FSS = 0.6 =
P(FSS | oil)
• If there is no oil, then
• the probability that seismic survey findings is USS = 0.8 =
P(USS | dry)
• the probability that seismic survey findings is FSS = 0.2 =
P(FSS | dry)

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 Bayes’ Theorem
• Calculate posterior probabilities using Bayes’ theorem:
Given P(X = xj |  = k), find P( = k | X = xj)

P(X  x j |    k ) P(   k )
P(   k | X  x j ) 
 P(X  x
i
j |   i ) P(  i )

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 Goferbroke Example (cont’d)
Optimal policies
• If finding is USS: State of Nature
Expected
Action Oil Dry
Payoff

Drill for oil 700 -100

Sell the land 90 90
Posterior probability
• If finding is FSS: State of Nature
Expected
Action Oil Dry
Payoff

Drill for oil 700 -100

Sell the land 90 90
Posterior probability
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 The Value of Experimentation

• Do we need to perform the experiment?

– As evidenced by the experimental data, the experimental
outcome is not always “correct”. We sometimes have
imperfect information.
• 2 ways to access value of information
• Expected value of perfect information (EVPI)
– What is the value of having a crystal ball that can identify true state of
nature?
• Expected value of experimentation (EVE)
– Is the experiment worth the cost?

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 Expected Value of Perfect Information
• Suppose we know the true state of nature. Then we will pick
the optimal action given this true state of nature.

State of Nature
Action Oil Dry
Drill for oil 700 -100
Sell the land 90 90
Prior probability 0.25 0.75

• E[PI] = expected payoff with perfect information =

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 Expected Value of Experimentation
• We are interested in the value of the experiment. If the value
is greater than the cost, then it is worthwhile to do the
experiment.
• Expected Value of Experimentation:
EVE = E[EI] – E[OI]
where E[EI] is expected value with experimental information.

E [EI ]   E [value | experimental result j ] P (result j )

j

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 Decision Tree
• Tool to display decision problem and relevant computations
• A decision tree consists of 3 types of nodes:-
1. Decision nodes - commonly represented by squares
2. Chance nodes - represented by circles
3. End nodes - represented by triangles/ellipses
• A decision tree has only burst nodes (splitting paths) but no
sink nodes (converging paths) on a decision tree branch

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 Decision Tree Example

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 Analysis Using Decision Trees
• Start at the right side of tree and move left a column at a time.
For each column, if chance fork, go to (2). If decision fork, go
to (3).
• At each chance fork, calculate its expected value. Record this
value in bold next to the fork. This value is also the expected
value for branch leading into that fork.
• At each decision fork, compare expected value and choose
alternative of branch with best value. Record choice by putting
slash marks through each rejected branch.
• Comments:
• This is a backward induction procedure.
• For any decision tree, such a procedure always leads to an optimal solution.

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 Decision Tree Advantages
• Are simple to understand and interpret
• Have value even with little hard data
• Possible scenarios can be added
• Worst, best and expected values can be determined for
different scenarios
• Use a white box model. If a given result is provided by a
model
• Can be combined with other decision techniques
• e.g. Net Present Value calculations

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