Econ 6036 Spring 2012

Problem Set 1: Nash Equilibrium, Rationalizability, Extensive Form Games

with Perfect and Complete Information, Repeated Games.
The due date for this problem set is Mar 5. You should either email me your
problem set or hand it in to my mailbox in the General Oce at 9F KKL.
1. Private Voluntary Contribution to a Public Good. Consider an elderly person
who needs to cross the street but is unable to do so alone. There are : bystanders. If
the elderly person crosses the street successfully, each bystander gets utility n because
he/she cares about the welfare of the elderly person. However, helping the elderly
person across the street means interrupting their current activity which has an oppor-
tunity cost c independent of whether other agents are already assisting or not. One
person is sucient to help the person cross the street.
(a) Suppose rst that there is only one bystander. Derive a necessary and sucient
condition for the single bystander to help the elderly person without the possibility
of indierence. Assume in the following that this condition is always satised.
(b) Consider now the case of two bystanders. Describe the normal form of this game
in a bimatrix. (See Gibbons 1.1A for how to represent a normal form game in
bimatrix) What are the pure strategy Nash equilibria? Is there a symmetric
pure strategy Nash equilibrium? Compute now the symmetric mixed strategy
Nash equilibrium.
(c) Consider now : bystanders and compute the symmetric mixed strategy equi-
librium. How does the likelihood by which an individual assists changes as :
increases?
(d) How does the probability that the elderly person receives assistance changes as :
increases?
2. Let G =
_
`. (o
i
)
N
i=1
. (n
i
)
N
i=1
_
be a nite normal form game. Suppose o

is a mixed
strategy Nash equilibrium of G. Show that for all i = 1. .... `, every pure strategy :
i
in the support of o

i
survives iterative deletion of strictly dominated strategies. You
cannot simply invoke a theorem stating this result. You can use other theorems proved
in class.
3. Consider a voting game in which three players, 1,2, and 3, are deciding among three
alternatives, A, B, and C. Alternative B is the status quo and alternatives A and
C are challengers. At the rst stage, players choose which of the two challengers
should be considered by casting votes for either A or C, with the majority choice bing
the winner and abstentions not allowed. At the second stage, players vote between the
status quo B and whichever alternative was victorious in the rst round, with majority
rule again determining the winner. Players vote simultaneously in each round. The
players care only about the alternative that is nally selected, and are indierent as
to the sequence of votes that leads to a given selection. The payo functions are
n
1
() = 2, n
1
(1) = 0, n
1
(C) = 1; n
2
() = 1, n
2
(1) = 2, n
2
(C) = 0; n
3
() = 0,
n
3
(1) = 1, n
3
(C) = 2.
1
(a) Describe a strategy for player 1.
(b) What would happen if at each stage the players voted for the alternative they
would most prefer as the nal outcome?
(c) Find a subgame-perfect equilibrium. What is the outcome of the subgame-perfect
equilibrium that you found?
(d) What is the subgame-perfect equilibrium outcome if instead of alternative 1,
alternative is the status quo? This illustrates that dierent agendas for
arriving at a nal decision by voting between two alternatives at a time would
lead to a dierent equilibrium outcome.
4. An All-Pay Auction. A 3-dollar bill is for sale. There are two bidders. Bidders
choose their bids /
i
in f0. 1. 2. 3g simultaneously. Payo functions are given by
n
i
(/
i
. /
j
) =
_
_
_
3 /
i
3
2
/
i
/
i
if /
i
/
j
if /
i
= /
j
if /
i
< /
j
.
So if both players bid 0, the payo to each of them is
3
2
.
(a) NE
1. Show that there are no pure strategy Nash equilibria in this game.
2. Find a symmetric mixed strategy Nash equilibrium (

) for this all-pay

auction. You can follow the steps below:
1. Show that it cannot be the case that

puts probability 0 on both bidding

0 and bidding 3.
2. Given that either bidding 0 or bidding 3 receives strictly positive proba-
bility under strategy

, bidding 3 cannot be in the support of

.
3. We can conclude from the previous two steps that the support of

is
f0. 1. 2g. We can then nd the unique symmetric mixed-strategy Nash
equilibrium for this game.
(b) Suppose this auction is played twice. That is, on day 1, a 3-dollar bill is auctioned
o in the manner described above. On the second day, another 3-dollar bill is
auctioned o in exactly the same manner.
1. Write down the normal form representation of this two-stage game.
2. Draw a game tree representing this dynamic game. Write the identity of the
player next to every decision node. Connect the decision nodes that are in
the same information set by a dashed line. Write the payo to each player
at every terminal node.
3. Let ,
k
i
be the pure strategy for player i that bids $0 on day 1, while on day
2, bids $/ if both bid $0 on day 1 and bids $3 otherwise. Let

(/) denote
the probability that the mixed strategy

puts on bidding $/. (

is the
mixed strategy in the symmetric NE for question 4(a)2) Let ^ o
i
be the mixed
strategy for player i that puts probability

(/) on pure strategy ,

k
i
. Show
that (^ o
1
. ^ o
2
) is a Nash equilibrium in this dynamic game.
2
4. Is (^ o
1
. ^ o
2
) a subgame perfect Nash equilibrium? Why or why not?
5. Find a symmetric subgame-perfect Nash equilibrium in this dynamic game.
Are there other symmetric subgame-perfect Nash equilibrium in this dynamic
game?
5. Alternating Oer Bargaining Game with 3. There are three players i 2 f1. 2. 3g who
have to reach an agreement r 2 A =
_
r
1
+ r
2
+ r
3
:

i=1;2;3
r
i
= 1
_
. Players share
a common discount factor o. That is, if agreement is reached in period t, where
t = 1. 2. ..., payo to player , is o
t1

j
. Call player i + 1 the player whose index is the
remainder of i + 1 divided by 3. At period 3/ + i for / = 0. 1. 2. ... and i 2 f1. 2. 3g,
player i makes an oer r 2 A, which player i + 1 chooses to accept and reject. If
player i +1 rejects, the game moves on to the next period. If player i +1 accepts, then
player i + 2 chooses to accept or reject is oer r. If i + 2 also accepts, then each the
agreement r is implemented. If player i + 2 rejects, then the game moves on the the
next period.
(a) Find a SPNE in which the agreement
_
1
1++
2
.

1++
2
.

2
1++
2
_
is reached immedi-
ately. (Hint: the construction is similar to the SPNE with 2 players)
(b) Consider the following strategy. Start the game in R(1) phase. Suppose history /
t
belongs to R(i) phase, where i 2 f1. 2. 3g. Then the proposer proses to give $1 to
player i and $0 to the other two and the respondents accept this proposal. If the
equilibrium proposal is rejected by one respondent, the history remains in R(i)
phase. If the proposal (r
1
. r
2
. r
3
) is not equal to the equilibrium proposal, then
player , 6= i that receives less than the other respondent in the proposal r rejects
the proposal and player / 6= i that receives more than the other respondent in
r accepts the proposal. In addition, the history after this proposal r is rejected
belongs to R(,) phase.
Show that this strategy prole is a SPNE for all o
1
2
.
6. Repeated Bertrand competition.
(a) First consider the static Bertrand competition. Firm 1 and 2 produce homoge-
neous product at zero marginal cost. There are no costs other than marginal costs
and no capacity constraint. Firm 1 and 2 choose prices j
1
and j
2
simultaneously
where j
i
0 for i = 1. 2. Market demand function is 1 = c Q where c 0.
The rm with the lower price meets all the market demand. If both rms charge
the same price, then the market is split equally between the two.
1. Write down the normal form representation of the game.
2. If rm 1 and 2 were to charge the same price j, what is the common price j
that maximizes the sum of their prots? (This is the monopoly price)
3. Show that in the static Bertrand Competition, the unique NE is for each rm
to charge j = 0.
(b) Consider the innitely repeated Bertrand competition with common discount fac-
tor o.
3
1. Draw the set of feasible (with public randomization device) and individually
rational payo proles.
2. Find the lowest o 0 such that there exists a SPNE in which both rms
charge the monopoly price for all o o. Find such a SPNE as well.
(c) Consider the innitely repeated Bertrand competition with demand shocks. Sup-
pose c = 4 with probability
1
2
and c = 8 with probability
1
2
. In each period, rms
observe the demand function before choosing their prices.
1. Find the lowest o 0 such that there exists a SPNE in which both rms
charge the monopoly price for all o o. Find such a SPNE as well.
2. Show that if (:

1
. :

2
) is a SPNE, then (^ :
1
. ^ :
2
) is a SPNE where
^ :
i
(/) = :

i
(/) if / is on the equilibrium path.
^ :
i
(/) = 0 if / is o equilibrium path.
3. Show that for o <
1
2
, there exists no symmetric SPNE in which rms get
positive prot. Show this by going through the following steps. Denote by

L
and
H
the subgame following a period where c = 4 and c = 8 respectively.
Let n
L
be the highest payo of a rm in a symmetric SPNE in
L
and n
H
be
that in
H
.
1. Let (:

. :

) be a symmetric SPNE. Let n

L
be the current
max fn
L
. n
H
g
o
1 o
_
1
2
^ n
L
+
1
2
^ n
H
_
where n
L
and n
H
is the current period prot in equilibrium (and thus also
the maximal current deviation gain) given c = 4 and c = 8 respectively,
while ^ n
L
and ^ n
H
is the average payo in the subgame from next period on
if next periods demand is 1 and H on the equilibrium path. Therefore,
max fn
L
. n
H
g
o
1 o
_
1
2
n
L
+
1
2
n
H
_
.
This has to hold for all SPNE n
L
and n
H
. Thus
max fn
L
. n
H
g
o
1 o
_
1
2
n
L
+
1
2
n
H
_
.
Thus
max fn
L
. n
H
g
o
1 o
max fn
L
. n
H
g ,
which cannot hold for o <
1
2
.
4. For o 2 [
1
2
. o) where o) is your answer to Q6(c)1, nd the maximal n
H
such
that there exists a symmetric SPNE in which rms share the monopoly prot
when c = 4 and makes prot n
H
when c = H.
7. Consider this repeated Prisoners dilemma game with imperfect monitoring. Payo
matrix of the stage game is by Table 1. At the end of each period, players do not
observe the action prole chosen, but observe a public signal in f:c:c. di,,g. Given
the action prole (c
1
. c
2
) of the period, if c
1
= c
2
, then the public signal is :c:c with
probability (1 j) and di,, with probability j, while if c
1
6= c
2
, the public signal is
:c:c with probability (1 ) and di,, with probability . Suppose =
3
4
and j =
1
8
.
4
C D
C 2,2 -1,4
D 4,-1 0,0
Table 1: PD game
(a) Trigger strategy: play C in the beginning and if has been :c:c in every period
so far. Play 1 otherwise. What are the necessary and sucient conditions on o
and j and such that it is a perfect public equilibrium for both to use the trigger
strategy.
(b) Find
L
and
H
such that the payo prole is (
H
.
L
) if players choose (1. C) in
the beginning and the continuation prole is (
L
.
H
) if signal is di,, and (
H
.
L
)
if signal is :c:c.
(c) Show that the set of prole proles f(
H
.
L
) . (
L
.
H
)g is self-generating for o =
1
2
,
j =
1
8
and =
1
2
.
(d) Find a perfect public equilibrium for o =
1
2
, j =
1
8
and =
3
4
where payo prole
is (
H
.
L
).
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