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Topic #3
A Game Against Nature part of what is generally called decision theory (rather than game theory) because there is only one player who
makes a rational choice, and is interested in (gets a payoff, i.e., a gain or loss, from) the outcome.
s1 s2 s3 s4 s5
x y z v w
the decision problem is conceptually trivial, i.e., P1 should choose the strategy that gives him the best outcome,
in this case s2.
However, such decision problems are often difficult in practice, because the decision maker may not know how to predict or evaluate the payoffs from the different outcomes,
but this problem is essentially one of information and research, not strategic choice.
But decision/game theory focus on the problem of strategic choice, and assumes that all players know their payoffs.
A payoff matrix is set up as a crosstabulation of P1 s strategies and Nature s contingencies (or another player s strategies).
This is the simplest possible non-trivial matrix , with two rows and two columns.
Numbers in each cell of a payoff matrix indicate the payoff (or at least rank the payoffs) to each player given by the resulting outcome.
In this case, there is only one number in each cell because there is only one player, and nature is indifferent among outcome and has no payoffs.
We now identify several different decision principles (some of which may be poor principles) that player P1 might use in order to pick his strategy. The Maximax Principle (informally, aim for the best ):
choose the strategy that can give you the best outcome. In this case, maximax says choose s2.
Note however that s2 can also give you your worst outcome,
so maximax can mean aim for the best --- but get the worst.
In this case ,
the security level of s1 is 2, while the security level of s2 is 1.
Then choose the strategy that gives you the highest security level,
i.e., the maximum of the minimums or maximin.
In this case, s1 is P1 s maximin strategy, and by using it P1 can guarantee a payoff of at least 2, regardless of what Nature does.
Principle of Expected Utility (or Payoff) Maximization: The payoff matrix has been modified to show cardinal (or interval), rather than merely ordinal, payoffs. Choose the strategy that gives you the highest expected payoffs, weighting each contingency by its (objective or subjective) probability. This requires that payoffs are cardinal (or interval) in nature and the decision maker knows the probability over nature s contingencies . Given p = p = .5, the expected payoff from s1 = 6 and from s2 is 5, so P1 should choose S1. If p = .25 and p = .75, the expected payoff from s1 is 7 and from s2 is 7.5, so P1 should choose s2.
1 2 1 2
If rain is certain, P1 definitely should take his umbrella If shine is certain, P1 definitely should not take his umbrella How probable does rain have to be so that P1 (if he is maximizing expected payoffs) should choose to take his umbrella?
Put otherwise, what is the probability rain that leaves P1 indifferent between his two strategies (because they have the same expected payoffs)?
Let p (0 < p < 1)be the probability of rain, so the probability of shine is (1-p).
Expected Payoff from S1 = Expected Payoff from S2 4p + 8(1-p) = 0p + 10(1-p) 6p = 2 p = 1/3 (and p = 2/3) In which case the expected payoff from s1 = 4/3 + 16/3 = 20/3 = 7.333 , The expected payoff from s2 = 0/3 = 20/3 = 7.333
Cardinal Payoffs $$
Generally, you can think of cardinal payoffs as being essentially equivalent to money, but not always. Consider a game with two players plus Nature:
P1 is you, deciding whether to buy home-owner s (fire) insurance; P2 is an insurance company, deciding whether to sell you a policy; Nature decides whether your home will burn down in the next year.
If you and the insurance company have the same beliefs about the probability that your house will burn down in the year, is there a premium price such that you will buy and they will sell
Not if payoffs = expected $$$. You probably are not risk-neutral but rather risk-averse. But the insurance company, insuring millions of widely dispersed house, can afford to be risk neutral.
Ditto in a game between you, a Las Vegas gaming house, and Nature. If you win the state lottery, are you indifferent between these two prizes?
Prize 1: $1,000,000 Prize 2: Another lottery ticket, which gives you a .5 chance of winning $2,000,000 and a .5 chance of winning $0.
But can you see another and very persuasive decision principle lurking in this example?
In the payoff matrix above, s2 dominates both s1 and s3, so P1 should not choose s1 or s3. Put otherwise, S2 is at least as good a reply as s1 (or s3) in every contingency and is a better reply in at least one contingency.
In the modified payoff matrix above, s2 now dominates s4 (as well as s1 and s3),
so s2 is a dominant strategy.
A dominant strategy if a best reply in every contingency. Corollary of Dominance Principle: If you have a dominant strategy, use it. Notice that the Dominance Principle does not
require cardinal payoffs in order for it to be applied, and does not depend on the probabilities of the contingencies.
s2 cannot be uniquely maximax; S2 cannot be uniquely minimax S2 cannot have a higher average payoff S2 cannot have a higher expected payoff.
But typically players may have many (even only) undominated strategies and
only rarely do players have dominant strategies.
Therefore, while the Dominance Principle is very good advice where it applies, it very often does not apply.