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					                 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

               A game is any situation where the outcome of
                your actions depends on the actions of others



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            Games We Play




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            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

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            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?
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            Games

             Board games, card games, video games,
             sports games, computer games

             Real   Life Games:
               Notwin-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
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            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


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                “Game theory is hot”
                     — The Wall Street Journal, 13 February 1995


            Students trained in game theory work for

               federal regulatory agencies      human resource departments
               financial firms                  pricing divisions
               strategy consultancies           intelligence agencies
               public policy firms              the military
               political campaigns              sports teams


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            A Brief History




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      Game Theory




Administratrivia
            Course Information

               Textbook
                     Not required
               Course web site
                     Check after each lecture
               Course discussion
                     Questions, comments




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            Course Outline
            Concepts

               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

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            Course Outline
            Applications

               Winning the game

                   Strategic   moves
                    Credibility, threats, and promises
                   Information
                    Signaling, screening, incentives
                   Bargaining & Auctions
                    Participating and designing



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            Games

               Participate by midnight 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
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            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.

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            Grading

             Midterm                 20 %
             Final Exam              35 %

             Quizzes (and Assignment) 25 %
             Class Participation      10 %
             Games (participation)    10 %


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            Keys to Success

               After each lecture:
                    Visit course web site
                    Do assigned readings
                    Do sample problems


               Ask questions

               Don’t fall behind
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            Policies
                   They have a lovely
                       “No cell phone”
                        policy here…




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            Interactive Decision Theory



               Decision Theory
                   You are goal-driven and considering your options


               Game Theory
                   So is everyone else



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            The Golden Rule



              Never assume that your opponents’
                       behavior is fixed.
             Predict their reaction to your behavior.




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            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


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            Restaurant Decision-Making
                      May I recommend that with the Bleu
                        Cheese for ten dollars more?

                                                     Sure!


                                                     It is only
                                                   a dollar more
                                                      for me!


               Check splitting policy changes incentives.
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            Understanding Incentives


               Do bicycle helmets cause fewer injuries?

               Should airplanes require children to
                be in their own seats?




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            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?


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            Decision Theory

             Free money!
             Pick an option:


                 Option 1:   $50
                 Option 2:   $40
                 Option 3:   $20



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            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



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            The Golden Rule



            Spend as much time thinking about your
            opponents’ strategy as you do your own.




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            Is Game Theory Moral?


                          ‘Game Theory’ Excuse for Anything
                            A student cheats on his exam. A corporation fudges its        Game theory goes on to say that you should expect
                          accounts to boost its stock price. A professor lies about     people to lie, and so you also might want to lie. Isn't this
                          his past. A politician sends out a newsletter with one        a wonderful concept to be teaching our college students?
                          opinion to one group of constituents, another newsletter        Here's a quote from one of the textbooks used in game
                          with an opposing opinion to another group. A store            theory courses, ''Thinking Strategically,'' by Avinash
                          chain uses underhanded methods to gain locations. Are         Dixit and Barry Nalebuff: ''Individuals' incentive to
                          these all independent actions, or part of a larger attitude   cheat on any agreement should be recognized and made
            Teddy Milne   that's eating away at ethics in this country?
                            To me, they seem part of the ''realist'' approach to
                                                                                        a part of their strategy choice.'' In a roundabout way, this
                                                                                        teaches that cheating is not only acceptable, but to your
                          politics, especially as exemplified by ''game theory.''       advantage.
                            Game theory starts out by saying forget about                 Further, game theory suggests that in order to get a
            October 22,   morality, feelings and emotions; we are going to assume       competitive edge, you might want to pretend to be
            2002          that a rational person is going to always act in his own
                          best interests.
                                                                                        insane, so that your opponent won't be able to judge
                                                                                        which way you're going to jump.
                            In other words, self-interest is king, a theory as old as     Well, we've seen that in politics, haven't we? Perhaps
                          man. Thucydides noted it in 400 B.C. Machiavelli              Dr. Strangelove was only pretending. However, this
                          described it in the 16th Century, and perhaps every           seems in reality a pretty insane course to take, and
                          generation has come up with theories, explanations and        might easily have unintended consequences.
                          justifications for acting selfishly.                                                 (see “Mindless Commentary”, p. 3)




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            A Game




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            A Game - Redux




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            Next Time


               The rules of a game
               The assumptions of game theory



               Our first online game




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