Game Theory for Managers

Problem Sheet

Q. 1 Three divisions of an army defend a town, which has two roads approaching it. The town is attacked
by two divisions of army I, either one along each road, or two along the same road. The defenders,
army II, can either put all three divisions to guard one road or two to guard one road, and one the
other. Whichever army had more divisions on a given road will command the road. If there are equal
number of defenders and attackers on the same road, then half the time the defender will hold the
road and half the time the attackers will enter the city. Calculate the payoff matrix of the attackers’
chances of entering the town. Hence, find the value of the game and optimal strategies.

Q. 2 Player 1 has two aircrafts, and player 2 has four missile batteries to cover four approaches to a target.
Each battery can shoot down with certainty one aircraft, if it attacks along that approach, but only
one aircraft since the reloading time is long. The payoff to player 1 is 1 if an aircraft gets through and
so destroys the target and 0 otherwise. Find the pay-off matrix to model this as a zero-sum game.

Q. 3 Two manufacturers currently are competing for sales in two different but equally profitable product
lines. In both cases, the sales volume for manufacturer 2 is three times as large as that for manufac-
turer 1. Because of a recent technological breakthrough, both manufacturers will be making a major
improvement in both products. However, they are uncertain as to what development and marketing
strategy to follow.
If both product improvements are developed simultaneously, either manufacturer can have them ready
for sale in 12 months. Another alternative is to have a crash program to develop only one product first
to try to get it marketed ahead of competition. By doing this, manufacturer 2 could have one product
ready for sale in nine months, whereas manufacturer 1 would require 10 months (because of previous
commitments for its production facilities). For either manufacturer, the second product could then
be ready for sale in an additional nine months.
For either product line, if both manufacturers market their improved models simultaneously, it is
estimated that manufacturer I would increase its share of the total future sales of this product by 8
percent of the total (from 25 to 33 percent). Similarly, manufacturer I would increase its share by 20,
30 and 40 percent of the total if it marketed the product sooner than manufacturer 2 by 2, 6, and 8
months, respectively. On the other hand, manufacturer 1 would lose 4, 10, 12, and 14 percent of the
total if manufacturer 2 marketed it sooner by 1, 3, 7, and 10 months, respectively.
Formulate this problem as a two-person, zero-sum game, and then determine which strategy the
respective manufacturers should use.

Q. 4 An enterprise has two companies, Fly-By-Night and Shady Dealings, which on average have tax bills
of $ 4,000,000 and $12,000,000, respectively, each year. For each company, the enterprise can either
admit (and pay) their true tax liability or falsify their accounts to show a zero tax liability. The
internal revenue service only has the resources to investigate one of the companies each year. If they
investigate a company with false returns, they will discover the fraud and the company will have to
pay the required tax plus a penalty of half as much again. Set this up as a zero sum game where the
payoffs are the money that the internal revenue service receives. Show that the enterprise will pay
an average of $14,000,000 to the IRS and find the optimal strategies for both players. Suppose the
penalty for fraud is increased to paying the required tax plus twice as much again. Solve this game
and describe the optimal strategies.

Q. 5 USA intelligence suspects that North Korea is thinking about starting a program to develop nuclear
missiles. This will dramatically affect the stability of the region. According to the testimony of
fugitives that abandoned the country, life conditions are very poor. This makes USA authorities
propose the following agreement to North Korea:

• USA will give a 25 billion dollars aid to North Korea if it abandons its nuclear program.
• The aid will be given once the agreement is signed, but North Korea promises to give it back if
the USA finds proof that the nuclear program is still on. Without the proof, North Korea will
not give the money back.

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 • To get the proof, USA can make the International Atomic Energy Agency inspect North Korean
installations. The cost of the inspection is 10 billions and will be paid by the USA.
• The USA finds that the stability of the region is worth 90 billion dollars, whereas for North
Korea, to give up its nuclear program has an estimated cost of 20 billion dollars.

Identify the set of strategies for each player, the payoffs and the normal form of the game. Find the
Nash equilibria of the game.

Q. 6 A slave has just been thrown to the lions in the Roman Colosseum. Three lions are chained down in
a line, with Lion 1 closest to the slave. Each lion’s chain is short enough so that he can only reach the
two players immediately adjacent to him. First, the Lion 1 decides whether or not to eat the slave. If
Lion 1 has eaten the slave, Lion 2 decides whether or not to eat Lion 1 (who is too heavy to defend
himself). If Lion 1 has not eaten the slave, then Lion 2 has no choice, he cannot try to eat Lion 1,
because a fight will kill both lions. Similarly, if Lion 2 has eaten Lion 1, Lion 3 decides whether or
not to eat Lion 2. Each lion’s preferences are fairly natural: best (payoff=4) is to eat and stay alive,
next best (payoff=3) is to stay alive but go hungry, next (payoff=2) is to eat and be eaten, and worst
(payoff=1) is to go hungry and be eaten.

• Draw the sequential game tree with payoffs for this game.
• What is the Rollback equilibrium for this game?
• Is there a first mover advantage to this game? Explain why or why not.

Q. 7 Find the pure-strategy subgame perfect equilibria of the game below.

Q. 8 A market consists of people with a left-handed glove (set L) and people with a right-handed glove (set
R) but not both. The value of a coalition is the number of complete pairs of gloves it has. Write the
characteristic function for the case when there are 2 people in L and 3 in R. Further, find the core.

Q. 9 In a 3-player game with characteristic function v(i) = 0; v(i, j) = a; v(1, 2, 3) = 3, for what values of
a is the core non-empty?