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2
1
A
B
C
D
E
F
7, 6
5, 8
7, 6
2
D
E
F
5, 8
7, 6
1, 1
2
D
E
F
0, 0
1, 1
4, 4
57
Chapter 8: Strategy and Game Theory
8.3 The question should refer to teens 1 and 2 throughout rather than teens A and B.
a.
b. (Dont veer, veer) and (veer, dont veer).
c. Let
2
1
Veer
Veer
Dont
veer
Dont
veer
2, 2
1, 3
2
Veer
Dont
veer
3, 1
0, 0
58
Chapter 8: Strategy and Game Theory
d. Teen 2 has four contingent strategies: always veer, take the same action as teen
1, do the opposite of teen 1, never veer. The normal and extensive forms for the
game are as follows.
Teen 2
(Veer | Veer
Veer | Dont)
(Veer | Veer
Dont | Dont)
(Dont | Veer
Veer | Dont)
(Dont | Veer
Dont | Dont)
T
e
e
n
1
Veer 2, 2 2, 2 1, 3 1, 3
Dont 3, 1 0, 0 3, 1 0, 0
0
Teen 1s
probability
of veering
Teen 2s
probability
of veering
1/2
1
1/2
1
BR
2
BR
1
E
1
E
2
Mixed-strategy
equilibrium
59
Chapter 8: Strategy and Game Theory
d. There are three Nash equilibria: 1 veers and 2 never veers, 1 doesnt veer and
2 always does, and 1 doesnt veer and 2 does the opposite of 1.
e. The game has three subgames: the game itself and the subgames starting from
the node at which teen 2 moves. The Nash equilibrium following 1s having
veered is for 2 not to and following 1s having not veered for 2 to veer. Thus 2s
strategy must be to do the opposite of 1 in a subgame-perfect equilibrium. Teen 1
thus would choose not to veer. The Nash equilibrium in which 2 always veers is
unreasonable because 2 would prefer not to veer if he sees 1 has first; the Nash
equilibrium in which 2 never veers is unreasonable because 2 would prefer to veer
if he sees 1 has not.
8.4 a. Homeowner 1s objective function is
1 2 1 1
4 ) 2 / 10 ( l l l l + . Taking the first-
order condition with respect to
1
l and rearranging yields the best-response
function 4 / 3
2 1
l l + . Symmetrically, homeowner 2s best-response function is
4 / 3
1 2
l l + . Solving simultaneously yields
4
*
2
*
1
l l
.
2
1
Veer
Veer
Dont
veer
Dont
veer
2, 2
1, 3
2
Veer
Dont
veer
3, 1
0, 0
60
Chapter 8: Strategy and Game Theory
b.
c. The change is indicated by the shift, following the arrow, in homeowner 1s
best response function. In the new Nash equilibrium, 1 mows a lot less and 2
mows a little less.
8.5 a. If all play blond, then one would prefer to deviate to brunette to obtain a
positive payoff. If all play brunette, then one would prefer to deviate to blond for
the higher payoff of
a
rather than b .
b. Playing brunette provides the male with a certain payoff of b . Playing blond
provides a payoff of
a
with probability
1
) 1 (
n
p
(the probability no other
player approaches the blond). Equating the two payoffs yields
) 1 /( 1 *
) / ( 1
n
a b p
.
c. The probability the blond is approached by at least one male equals 1 minus
the probability no males approach her:
) 1 /( *
) / ( 1 ) 1 ( 1
n n n
a b p
. This
expression is decreasing in
n
because the exponent
) 1 /( n n
is decreasing in
n
and the base of the exponent, a b / , is a fraction.
8.6 a. Player 1s minmax value is 0, achieved if 2 plays the pure strategy B. Player 2
can cause more harm to 1 by playing the mixed strategy of B with probability
9/10 and C with probability 1/10. Then 1s highest expected payoff is -1/10.
0
3
3
l
1
l
2
4
4
BR
1
(l
2
)
Initial Nash
equilibrium
BR
2
(l
1
)
61
Chapter 8: Strategy and Game Theory
b. Each player can play the strategy of beginning with A in the first period. If no
one deviated from A, C is played; otherwise B is played. Players earn a total of 18
each in equilibrium with these strategies (10 in the first period and 8 in the
second). The strategies are subgame perfect. In the second period, a Nash
equilibrium is always played, either (B, B) or (C, C). There is no incentive to
deviate in the first period: the first-period gain from deviation of 5 is less than the
second-period loss from moving to the less-preferred Nash equilibrium of 8.
c. The outer polygon is the feasible set; payoffs in the shaded region are
additionally above the minmax levels and thus are achievable in the limit.
8.7 a. The best-response function is
4 / 5 . 3
2
l l
LC
+
for the low-cost type of player
1,
4 / 5 . 2
2
l l
HC
+
for the high-cost type, and 4 / 3
1 2
l l + for player 2,
where
1
l is the average for player 1. Solving these equations yields 5 . 4
*
LC
l ,
5 . 3
*
HC
l , and
4
*
2
l
.
b. Player 2 best responds to the average best response across the two types of
player 1, given by the dashed line between the two best responses, and resulting in
a choice of landscaping level given by the dotted horizontal line. The two types
0
u
1
5 10
-5 -10
5
10
-5
-10
u
2
62
Chapter 8: Strategy and Game Theory
of player 1 best respond to the equilibrium landscaping effort of player 2,
resulting in the outcome labeled HC if player 1 is the high-cost type and LC if
player 1 is the low-cost type.
c. The low-cost type of player 1 earns 20.25 in the Bayesian-Nash equilibrium
and 20.55 in the full-information game, so would prefer to signal its type if it
could. Similar calculations show that the high-cost player would like to hide
its type.
8.8 a.
l
1
l
2
BR
HC
(l
2
)
BR
2
(l
1
)
BR
LC
(l
2
)
LC
HC
63
Chapter 8: Strategy and Game Theory
b. In a hybrid equilibrium, at least some type of some player plays a mixed
strategy. If player 1 sees the low card, she prefers the pure strategy of staying.
So it must be that player 1 randomizes after seeing a high card. (Verify that if
player 1 plays a pure strategy of either folding or staying, player 2s best
response is also a pure strategy, so the equilibrium would not be a hybrid one.)
For brevity, we will say that player 1 is the high type if she sees a high card
drawn and a low type if she sees a low card drawn. Let
and 1 be the
probabilities that the high type stays and folds, respectively. In order for the
high type to be willing to randomize, it must be that player 2 randomizes as
well. (Verify that this is the case.) Let
and
1
be the probabilities that
the high type stays and folds, respectively.
must be such that the high type is indifferent between staying and folding
for her to be willing to randomize. Staying provides the high type with an
expected payoff of
) 50 )( 1 ( ) 100 ( +
, and folding provides her with a
payoff of -50. Equating these two expressions and solving yields
3 / 2
*
.
In order for player 2 to be willing to randomize, he must be indifferent
between staying and folding. His expected payoff from staying is
1
Pr(H)
= 6/13
Stay
Fold
2
-50, 50
n
1
n
2
Fold
Stay
Pr(L)
= 7/13
-50, 50
Stay
Stay
Fold
Fold
100, -100
50, -50
50, -50
-100, 100
64
Chapter 8: Strategy and Game Theory
) 100 )]( | Pr( 1 [ ) 100 )( | Pr( + stay H stay H
where
) | Pr( stay H
is the posterior probability that player 1 is the high type
conditional on her staying. Player 2s payoff from folding is -50. Equating
the two expected payoffs yields
4 / 1 ) | Pr( stay H
.
) | Pr( stay H
must also
satisfy Bayes rule:
.
7 6
6
) 13 / 7 )( 1 ( ) 13 / 6 (
) 13 / 6 (
) Pr( ) | Pr( ) Pr( ) | Pr(
) Pr( ) | Pr(
) | Pr(
+
L L stay H H stay
H H stay
stay H
Equating this last expression with
4 / 1 ) | Pr( stay H
and solving yields
18 / 7
*
.
To summarize, in the hybrid equilibrium, the low type always stays, the high
type mixes between staying and folding with probabilities 7/18 and 11/18, and
player 2 randomizes between staying and folding with probabilities 2/3 and
1/3. Player 2s posterior beliefs are that player 1 is the high type with
certainty if she folds; if she stays she is the high type with probability 1/4 and
the low type with probability 3/4.
c. The low types expected payoff is (100)(2/3) + (50)(1/3) = 83.3. The high
types expected payoff is -50 (she is indifferent between staying and folding in
equilibrium, and earns -50 from folding). Given the prior probabilities of
being a high and low type, player 1s expected payoff from the game (prior to
learning her type) is (83.3)(7/13) + (-50)(6/13) = 21.8. Player 2s expected
payoff is -50 (he is indifferent between staying and folding in equilibrium and
earns -50 from folding). The game is clearly tilted toward player 1.
Analytical Problems:
8.9 Dominant strategies
For any strategy profile besides the dominant-strategy equilibrium, each player
would have an incentive to deviate to its dominant strategy, ruling out the profile
as a Nash equilibrium.
65
Chapter 8: Strategy and Game Theory
8.10 Rotten Kid Theorem
In the second stage, the parent chooses L to maximize
) ) ( ( ) ) ( (
1 1 2 2
L r Y U L r Y U + +
yielding first-order condition
0 ) ) ( ( ) ) ( (
1 1 2 2
+ + L r Y U L r Y U .
Even though the preceding equation cannot be solved explicitly for
) (
*
r L
, we can
still use the implicit function rule to find the derivative
1 2
1 1 2 2
*
) ( ) (
U U
r Y U r Y U
dr
dL
+
.
In the first state, the child maximizes
)) ( ) ( (
*
1 1
r L r Y U
, yielding first-order
condition
. 0
)] ( ) ( [
)] ( ) ( ) )( ( [
) (
2 1
1 2
2 1
1 1 2 2 1 2 1
1 2
1
*
1 1
,
_
+ +
,
_
1
1
]
1
+
r Y r Y
U U
U U
r Y U r Y U U U r Y
U U
U
dr
dL
r Y U
,
_
+ +
1
2
1 3
2
.
The deviator earns 3 in the first period, followed by a period in which both fink
and earn 1, followed by a return to cooperating in the third period and thereafter.
For the displayed payoff not to exceed
) 1 /( 2
, 1 , that is, players must be
infinitely patient.
If players use two periods of punishment, the present discounted value from
deviating is
,
_
+ + +
1
2
1 1 3
3 2
.
For the displayed payoff not to exceed
) 1 /( 2
, we see, upon multiplying
through by 1 and simplifying, the required condition is
0 1 2
3
.
Factoring,
) 1 )( 1 ( 1 2
2 3
+
. Hence, the required condition can be
written
0 1
2
+
. Using the quadratic formula to obtain the roots of this
quadratic, we have 62 . 0 .
b. The required condition is that the present discounted value of the payoffs from
cooperating,
) 1 /( 2
, exceed that from deviating,
) 1 /( 2 ) 1 /( ) 1 ( 3
11 10
+ +
. Simplifying,
0 1 2
11
. As the
graph below shows, the expression
1 2
11
crosses the x-axis very slightly to
the left of 0.5. Using numerical methods or a more precise graph, it can be shown
that the condition is 50025 . 0 . The resulting condition is very close to the
condition for cooperation with infinitely many periods of punishment ( 2 / 1 ).
67
-0.03
-0.02
-0.01
0
0.01
0.02
0.03
0.49 0.495 0.5 0.505 0.51
Chapter 8: Strategy and Game Theory
8.12 Refinements of perfect Bayesian equilibrium
a. The key condition is for the firm to be willing to offer a job to an uneducated
worker. (Regarding the other player, the worker, all worker types obtain the
highest payoffs possible, since they are hired and dont have to expend the cost of
education.) The firms expected payoff from J is
) )]( | Pr( 1 [ ) )( | Pr( w NE H w NE H +
and from NJ is 0. The displayed expression exceeds 0 if
/ ) | Pr( w NE H
.
According to Bayes rule, along the equilibrium path, posterior beliefs are the
same as prior beliefs in a pooling equilibrium. Therefore,
) Pr( ) | Pr( H NE H
.
The required condition for the specified pooling equilibrium thus is
/ ) Pr( w H
.
All out-of-equilibrium beliefs and strategies are consistent with this pooling
equilibrium. If
/ ) | Pr( w E H
, then the firm would choose J conditional on
observing E. On the other hand, if
/ ) | Pr( w E H
, then the firm would choose
NJ conditional on observing E.
b. For the firm to prefer not to offer a job to an uneducated worker, calculations
similar to those in part (a) (but with the inequalities reversed) imply
/ ) Pr( w H
. A high skilled worker would deviate to E unless the firm
chooses NJ conditional on E. The firm prefers NJ to J conditional on E when
the out-of-equilibrium posterior beliefs satisfy
/ ) | Pr( w E H
or
equivalently
/ 1 ) | Pr( w E L
. Suppose
L H
c w c < < . Then it would be
unreasonable to think that type L would ever deviate to E. Regardless of what
strategy the firm plays, type Ls payoff would be negative from E and non-
negative from NE. (By contrast, type H may have an incentive to deviate: he
or she earns a positive payoff if the firm plays J conditional on E.) The Cho-
Kreps intuitive criterion restricts the out-of-equilibrium posterior belief
0 ) | Pr( E L
. Since
0 ) | Pr( E L
is inconsistent with the required condition
68
Chapter 8: Strategy and Game Theory
/ 1 ) | Pr( w E L
, the Cho-Kreps intuitive criterion rules out the pooling
equilibrium specified in part (b), leaving only the one specified in part (a).
69