Game Theory is a fascinating field of study that has wide applications in various industries such as economics, political science, and even psychology. It is essentially a mathematical framework that attempts to analyze decision-making in situations where the outcome depends on the choices made by multiple individuals or entities. In this article, we will explore one of the fundamental concepts in Game Theory – Payoff Matrix, and learn how to calculate it.

## What is a Payoff Matrix?

In Game Theory, a Payoff Matrix is a table that shows the potential outcomes of a game based on the choices made by each player. The rows of the table represent the actions taken by Player 1, while the columns represent the actions taken by Player 2. The intersection of each row and column represents the outcome or payoff for each player based on their chosen action.

### Example:

Let’s consider a simple example to understand how a Payoff Matrix works. Suppose there are two players – Alice and Bob – who are playing a game where they have two options – cooperate or defect.

If both players choose to cooperate, they both get a reward of 3 units each. If both players choose to defect, they both get zero rewards. However, if one player cooperates while the other defects, then the defector gets a reward of 5 units while the cooperator gets nothing.

The Payoff Matrix for this game would look like this:

 Cooperate Defect Cooperate (3,3) (0,5) Defect (5,0) (0,0)
• The top-left cell represents the outcome when both players cooperate. In this case, both players get a reward of 3 units each.
• The top-right cell represents the outcome when Alice cooperates but Bob defects.

In this case, Alice gets nothing while Bob gets a reward of 5 units.

• The bottom-left cell represents the outcome when Bob cooperates but Alice defects. In this case, Bob gets nothing while Alice gets a reward of 5 units.
• The bottom-right cell represents the outcome when both players defect. In this case, both players get zero rewards.

## How to Calculate a Payoff Matrix?

To calculate a Payoff Matrix for any game, we need to follow these steps:

### Step 1:

Identify the players involved in the game and list their possible actions.

### Step 2:

Determine the payoffs for each player based on their chosen action and the action of the other player.

### Step 3:

Create a table with rows representing Player 1’s actions and columns representing Player 2’s actions.

### Step 4:

Fill in the cells of the table with each player’s payoff based on their chosen actions.

Let’s consider another example to understand how to calculate a Payoff Matrix. Suppose there are two companies – A and B – that are competing for market share in a particular industry. They have two strategies – advertising and not advertising.

If both companies advertise, they will split the market equally and earn a profit of 5 units each. If one company advertises and the other does not, the advertising company will capture the entire market and earn a profit of 10 units while the non-advertising company will earn only 1 unit. If both companies do not advertise, they will split the market equally but earn a profit of only 2 units each.