1. Managerial Economics Kyle Anderson
Game Theory I
Managerial Economics
Kyle Anderson
Indiana University
Kelley School of Business

2. Introduction to Game Theory
Strategic interaction between two or more players.
One shot, simultaneous move games.

3. Grading scheme: Choose a plan, Red or Blue.
Matched with a classmate (anonymously).
If you both choose the blue grade scheme, you both get an A-.
If you both choose the red grade scheme, you both get a B.
If you choose the blue scheme and your matched partner chooses red, you get a B- and your partner gets an A.
If you choose the red scheme and your matched partner chooses blue, you get an A and your partner gets a B-.
Which grade scheme do you choose?

4. Grading Game B+, B+ B-, A A, B- B, B Player 2 Two players
Simultaneous moves
Perfect information
One-time game
Blue
Red
B+, B+
B-, A
A, B-
B, B
Player 1
Normal form

5. Grading Game 3, 3 1, 4 4, 1 2, 2 Player 2 Blue Red Player 1
Red is the better strategy for Player 1, regardless of what Player 2 does. Dominant Strategy Player 2 has the same dominant strategy. Nash Equilibrium – each player is doing as well as it can do given its rivals actions.
Player 2
Blue
Red
3, 3
1, 4
4, 1
2, 2
Player 1
Normal form
A = 4, B+ = 3, B = 2, B- = 1

6. Nature of a game Frequency of movement Elements Nature of movement
One-shot game
Finitely repeated game
Infinitely repeated game
Nature of movement
Simultaneous-move game
Sequential move game
Elements
Players
Strategies
Payoffs
Information
Rationality

7. Pricing Game Simultaneous move, one-shot game
Two firms, each firm picks a price level (high or low), products are close substitutes.
Firms have some fixed costs.

8. Pricing Game 0, 0 40, -10 -10, 40 10, 10 Perry low price
Perry high price
Anderson low price
0, 0
40, -10
Anderson high price
-10, 40
10, 10
What strategies should the firms’ pursue?
*Anderson’s payoff is listed first, followed by Perry

9. Prisoners’ Dilemma
Perry low price
Perry high price
Anderson low price
0, 0
40, -10
Anderson high price
-10, 40
10, 10
One or more of the firms has a dominant strategy.
Pursuing the dominant strategy leads to an outcome that is sub-optimal for the players.
Of course, what is sub-optimal for the firm(s) may be optimal for others (i.e. customers).

10. Games with 3 or more options
Bar 2 $2 $4 $5
Bar 1
10 , 10
14 , 12
14 , 15
12 , 14
20 , 20
28 , 13
15 , 14
13 , 28
25 , 25
in thousands of dollars
If P2 plays $2: 5 > 4 > 2
Dominated Strategy: one that always leads to a lower payout than another available strategy.
If P2 plays $4: 4 > 2 > 5
If P2 plays $5: 4 > 5 > 2

11. Coordination Game 10, 10 0, 0 20, 20 Perry Southside Perry Northside
Anderson Southside
10, 10
0, 0
Anderson Northside
20, 20
How many NEs are there?

12. Coordination Game, sort of
Player 2
Red
Blue
Player 1
5, 1
0, 0
1, 5
How many NEs are there?

13. Introduction to Game Theory
One-shot, simultaneous move games
Look for a dominant strategy.
Look for opponent’s dominant strategy.
Look for dominated strategies.
Look for opponent’s dominated strategies.
Some games have multiple equilibria.
Next: Repeated games and sequential games.