Economics 203

Core Economics

January 2010
Suggested Solutions to Problem Bank1

1.

a) In the diagram, left branches mean heads and right branches mean tails.
N
1/3

1/3

1/3

!"#$%&'()*
!

*-.

2.

#
%

*-.
1

(2,-2)

*-.
2

"
/

"

(-2, 2) (-2,2)

(2,-2)
0

(-2,2)

(2,-2)

"

"
/

(2,-2)

0 (-2,2) (2,-2)
1 (-2,2)
%

(-2,2)

(2,-2)

b) Each player has 4 information sets, so strategies are 4-tuples.

S1 =+23+
{H, T3+2)+
} {H,
T}
{H,+23+
T } 3+2)+
{H, T3+2)+
}, which
16 elements.
3+2)+
+23+
+23+contains
+23+ 3+2)+
3+2)+ +23+
S2 = {h, t} {h, t} {h, t} {h, t}, which contains 16 elements.
a) The extensive form is:

!"#$%&'()+

"
/

*-+

*-+

*-+
8

.2+

425

.2*

*26

!
*-+

*2*

52+

*2*

+25

,2.

b) S1 = {H, M, T }
S2 !"#$%&'(),
= {(U, U ), (U, B), (D, U ), (D, B), (S, U ), (S, B)}
UU
H
(6, 4)
M
(1, 1)
T # (2.5, 2)

UB
(6,
< 4)
(6, 2)
(3, 4.5)

"

DU
DB
(3, 1.5) #-+(3, 1.5)
(1, 1)
(6, 2)
(2.5, #2) (3, 4.5)

SU
(2, 3.5)
#
(1, 1)
(2.5, 2)

SB
(2, 3.5)
(6, 2)
#
(3, 4.5)

Credit for many of the! solutions "is due to Doug Bernheim,

and "a series of previous
Daniel
!
! TAs, including
"
Fragiadakis, Marissa Beck, Tomas Rodriguez Barraquer, Ned Augenblick, Juuso Toikka, Xioachen Fen, Nageeb Ali,
Peter Coles, Mark Israel, Luis Rayo, Nese Yildiz, and others.

<2)#

<2)<

#-+2$#-+

<2)<

#2)<

<2)<

3. A strategy
QN includes one action from each information set. Thus, the number of strategies is
just n=1 Mn .
4.

a) The extensive form is:

b) S1 = {0, v/2, v}
S2 = {(a, a, a), (a, a, r), (a, r, a), (a, r, r), (r, a, a), (r, a, r), (r, r, a), (r, r, r)}
aaa
aar
ara arr
raa
rar
rra rrr
0
0, v
0, v
0, v 0, v
0, 0
0, 0
0, 0 0, 0
c)
v/2 v/2, v/2 v/2, v/2 0, 0 0, 0 v/2, v/2 v/2, v/2 0, 0 0, 0
v
v, 0
0, 0
v, 0 0, 0
v, 0
0, 0
v, 0 0, 0
d) No strategies are strictly dominated. One way to verify this is to note that every strategy
is a best response to some opponents strategy.
e) For player 1, 0 is weakly dominated by v/2 and v. For player 2, (a, a, a) and (a, a, r)
weakly dominate all other strategies.
5.

a) For player 1, E is strictly dominated by A. For player 2, a is strictly dominated by any

mixture of b and e, or d and e. The only weakly dominated strategies are the strictly
dominated ones.
b) Iterative deletion leaves (A, C, D) for player 1 and (b, c, e) for player 2, so the game is
not dominance solvable.
c) We only need to check the strategies that survive ISD. (C, c) is the unique PSNE.
d) In two player games, the set of strategies that survive iterative deletion is the same as
the set of rationalizable strategies. Thus, the answer is the same as in (b).

6. The question does not specify whether bids have to be non-negative; making either assumption
is fine. Let us assume that S1 = S2 = [0, 1), but if one made the alternative assumption,
the answers should not be too dierent.
a) No strategies are strictly dominated. Observe that if the opponent j makes demand
xj > 100, then all demands xi yield payo 0. Thus, no strategy xi can do strictly worse
than some other strategy for every choice of opponent strategy.
b) xi = 0 is weakly dominated by any xi 2 (0, 100]. xi > 100 is also weakly dominated by
any xi 2 (0, 100]. For any xi 2 (0, 100], xi is a strict best response to 100 xi , and thus
cannot be weakly dominated.
c) We can solve by graphing best response functions, or by inspection:
(x, 100 x) is a NE for any x 2 [0, 100].
We also have equilibria of the form (x1 , x2 ) where x1 , x2 100.
2

7. Let n denote a node that is reached in equilibrium. Playing c at node n can be a best response
only if the opponent plays c at node n + 1 with positive probability. Thus, if in equilibrium c
is played at node 1, then it must be played at every node with positive probability. But this
clearly is not an equilibrium, as playing c at the last node is not a best response. Therefore
c cannot be played in equilibrium at node 1.
Note 1: It is not hard to extend this result to mixed strategies.
Note 2: It is important to distinguish between Nash equilibria and equilibria outcomes here.
There are many pure strategy NE any profile where both players say stop at their respective
first nodes but there is a unique equilibrium outcome where stop is played at the first node.
Note 3: In eect, we have shown a stronger result: viz., in any rationalizable strategy profile,
player 1 says stop at the root node.
8. Let s be the unique strategy profile that survives iterated deletion of strictly dominated
strategies.
Step 1: No 0 6= s is a NE (where 0 can be a mixed strategy equilibrium).

There are many ways to prove this. An indirect (but elementary) approach would recognize
that a NE is a strategy-profile that necessarily lies within the set of rationalizable strategies.
Since that set is a subset of those remaining after iterated elimination of strictly dominated
strategies, a NE could not put positive weight on a strategy deleted by ISD. Since dominancesolvability implies that ISD leads to a unique strategy profile, s is the only strategy profile
that could be a NE.
One can also supply a direct proof: let s0i denote the first pure strategy in the support of 0
which was deleted, and suppose this took place in round k. Then there exists a randomization
i over is remaining strategies at the start of round k that beats s0i for any s i that remains
at the start of round k. In particular, because 0 i remains at the start of round k, we have
gi (i , 0 i ) > gi (s0i , 0 i ), so 0 cannot be a NE.
Step 2: s is a NE.
Suppose not. Then there exist i and si 2 arg maxsi gi (si , s i ) such that gi (
si , s i ) > gi (si , s i ).

But this implies that si 6= si could not have been deleted, a contradiction.
Note: we can relax the restriction that strategy sets be finite if we include an assumption
about existence of best responses:
Assumption 1 (A1) arg maxsi gi (si , s i ) 6= ; for all i, s i .

Claim Any dominance solvable game that satisfies (A1) has a unique NE which coincides
with the iterative dominance solution s .
9. Strategy sets are S1 = S2 = S3 = [0, 1]. Let p be the price of ice cream fixed by the
regulator and i designate payos for i=1,2,3. Note that in both parts of the question, the
best-response function is not always defined because of discontinuities (as in the Bertrand
game).
a) There are 3 cases to check:
Case 1: s1 = s2 = 12 . Here 1 = 2 = p2 , and any deviation yields payo < p2 . Thus,
( 12 , 12 ) is a NE.
Case 2: s1 = s2 6= 12 . Then 1 = 2 = p2 . However, if i deviates towards 12 by a small
amount, he secures more than half of the market and a payo > p2 . Thus, this is not a
NE.
3

Case 3: s1 6= s2 . This is clearly not a NE as either player can increase market share by
moving towards the other.
b) We will show that none of the 4 possibilities are Nash equilibria.
Case 1: s1 = s2 = s3 = 12 . Here 1 = 2 = 3 = p3 . By deviating to si + ", i secures
(1 ")p
> p3 . Thus, this is not a NE.
2
Case 2: s1 = s2 = s3 6= 12 . Again 1 = 2 = 3 = p3 . By moving " closer to 12 , i secures
more than half of the market and a payo > p2 . Thus, this is not a NE.
Case 3: si = sj 6= sk . Here k can clearly gain by moving closer to i and j. Thus, this is
not a NE.
Case 4: si < sj < sk . Again k can gain by moving closer to i and j. Thus, this is not a
NE.
Theses cases are exhaustive, so no pure strategy NE exists!
10. We begin by converting the problem to an equivalent one where strategy spaces are compact.
Claim: There exists q such that P (q) < C 0 (q) for all q > q.
This follows because P () is decreasing and concave and C 0 () is increasing.
Now observe that any strategy q > q is strictly dominated by q. Thus, we can throw out the
strictly dominated strategies and be sure that the set of equilibria is identical to that in the
original game. We now proceed in 4 steps:
a) There exists a pure strategy NE.
We verify the conditions of the existence theorem given in the notes:
- Strategy spaces are compact and convex by construction.
- Payo function gi (q1 , q2 ...qN ) = P (Q)qi C(qi ) is continuous.
- Payo function is gi (q1 , q2 ...qN ) is concave (thus quasi-concave) in qi :
@ 2 gi
= qi P 00 (Q) + 2P 0 (Q)
| {z } | {z }
@qi2
<0

<0

Thus, there exists a pure strategy NE.

C 00 (q ) < 0.
| {z i}
>0

b) Any pure strategy NE q must be symmetric.

P
P
Let Q = qi , and Q i =. j6=i qj .

i. q interior ) q symmetric:
We first establish that for a particular Q i , there exists a unique qi that is a best
response to it. qi is a best response to Q i if:
qi P 0 (qi + Q i ) + P (qi + Q i )

C 0 (qi ) = 0.

Since the LHS is decreasing in qi (by concavity as shown above), we are guaranteed
a unique best response. Let q (Q i ) = arg max P ( + Q i ) C().
Calculating the slope of the best response function, we see that
0>

@q
=
@Q i

P 0 (q + Q i ) + q P 00 (q + Q i )
>
2P 0 (q + Q i ) + q P 00 (q + Q i ) C 00 (q)
4

If there were an asymmetric equilibrium, then there exist i, j such that qi 6= qj . Then
q q
qi +Q i = qj +Q j , and hence, Q ii Qj j = 1. But qi = q (Q i ) and qj = q (Q j )
q (Q

) q (Q

i
j
since i and j are playing best responses. Therefore
= 1, which
Q i Q j
by the Mean Value Theorem contradicts our earlier slope calculation. Hence, all
solutions must be symmetric.
ii. q not interior ) q = (0, 0, ...0) (and thus symmetric):
q not interior ) qi = 0 for some i. Then from i0 s FOC, we have P (Q) C 0 (0) 0.
But for qj > 0,

qj P 0 (Q) + P (Q)

C 0 (qj ) < P (Q)

C 0 (0) < 0,

so no firm j can choose qj > 0 in equilibrium.

c) The symmetric equilibrium q is unique.
We know that the slope of the best-response function, q, is negative. Suppose there is
0
another symmetric equilibrium q 0 with WLOG, N qi = Q0 > Q = N qi .
But
Q0

>

Q ) Q0 i =

)
)

Q0 >

N
N
qi0 = q (Q0 i ) < q (Q i ) = qi

Q=Q

Q0 < Q,

a contradiction.
d) No mixed strategy equilibrium exists.
This follows from the concavity of the objective
function. Suppose in equilibrium is
P
opponents are mixing so that the sum
qj6=i takes on N values (generalization to a
continuous distribution is straightforward), with probabilities 1 , ..., N . Then i0 s choice
of qi solves
N

X
X
max
k qi P (qi +
qj6k=i ) C(qi ) .
qi 2[0,
q]

k=1

The objective is a weighted average of strictly concave functions and is thus strictly
concave. The choice set is compact. Thus, there is a unique optimum, so player i will
never mix!

11. The technique in this problem is to find pi (p), is best response to all other firms naming p,
and then to impose symmetry (finding p such that pi (p) = p).
Let i (pi , p) be the payo to firm i when i names pi and others name p. To calculate is
market share, we need to find the distance d to the consumer who is indierent between and
i and the next firm over.
Now d is defined by
v
which yields d =

J
2t (p

pi ) +

pi

td2 = v

t(

1
J

J
(p
t

d)2

1
2J .

We then have
i (pi , p) = (pi

c)2d = (pi
5

c)

pi ) +

1
.
J

is maximization problem yields FOC:

J
(p
t

pi ) +

1
+ (pi
J

c)(

J
) = 0.
t

In the symmetric Nash equilibrium, p = pi , so the FOC reduces to p =

name the same price, market share is 1/J for each firm.

t
J2

+ c. Since all firms

Note: its easy to check that when all other firms name p = Jt2 + c, a firm has no profitable
deviation to a price low enough to grab all customers between him and the next firm and
beyond.
As J grows large, pi ! c and qi ! 0. With many firms, i has arbitrarily close neighbors and
we approach the Bertrand outcome with no dierentiation.
As t ! 0, pi ! c but qi ! 1/J. As transportation costs approach zero, we have eectively
no product dierentiation and we approach the Bertrand outcome.
12. Note that the strategy set for i is Si = {Trade always, Trade i wi , Not trade i wi , Never
trade}. With that, we can write the normal form:
1/2
Trade always
Trade i w1
Not trade i w1
Never trade

Trade always
4 9p, 4 9p
p, 2p
4 10p, 4 7p
0, 0

Trade i w2
2p, p
0, 0
2p, p
0, 0

Not trade i w2
4 7p, 4 10p
p, 2p
4 8p, 4 8p
0, 0

Never trade
0, 0
0, 0
0, 0
0, 0

a) Since s i = Never trade results in a 0 payo always, i is indierent among all possible
strategies. Therefore, there are no strictly dominated strategies. The set of weakly
dominated strategies for player i is given by {Not trade i wi , Never trade}.

b) Once we delete weakly dominated strategies, the game reduces to:

1/2
Trade always Trade i w2
Trade always 4 9p, 4 9p
2p, p
Trade i w1
p, 2p
0, 0
From the above matrix, there are two NE:

i. (Trade always, Trade always), which gives each player a payo of 4 9p. Trade
occurs in all states and the expected total surplus is 8 18p.
ii. (Trade i w1 , Trade i w2 ), which gives each player a payo of 0. Trade never occurs
and the expected total surplus is 0.
c) From the above matrix, there is only one equilibrium: (Trade i w1 , Trade i w2 ), which
gives each player a payo of 0. Trade never occurs, and total surplus is 0.
d) The socially optimal strategy profile is (Not trade i w1 , Not trade i w2 ). Under such
strategies, trade occurs i the state is !3 , so that total surplus is 8 16p. These strategies
are not an equilibrium because each player would deviate to {Trade always}, given the
opponents strategy. That is, the socially optimal profile involves players not trading in
a state under which they would profit from trade: it requires an act of honesty when
there is an incentive to lie.
13.

a)

i. Any strategy with (wi , fi ) >> 0 is strictly dominated since player i could be better
o, regardless of player js strategy choice, by reducing both wi and fi by some
6

b)

14.

amount
> 0. Since wj 1600, any strategy of the form (0, fi ) with fi > 1100
is strictly dominated by (0, 1100). All of player is remaining pure strategies are
best responses to some pure strategy by player j: (wi , 0) is a best response to
(wj , fj ) = (0, wi 500) for 500 wi 1600, (wi , 0) is a best response to (wj , fj ) =
(500 wi , 0) for 0 wi 500, and (0, fi ) for fi 1100 is a best response to
(wj , fj ) = (500 + fi , 0). Thus, the set of strictly dominated pure strategies for player
i is precisely those with (wi , fi ) >> 0 and those with (0, fi ) such that fi > 1100.
ii. Since each strategy for player i that is not strictly dominated is a best response to a
pure strategy by player j that is not strictly dominated for player j, this is also the
set of strategies that survive iterated elimination of strictly dominated strategies.
iii. The set of pure strategy NE are pairs [(w1 , 0), (w2 , 0)] such that w1 + w2 = 500 as
well as pairs [(wi , 0), (0, fj )] such that 500 wi 1600 and fj = wi 500.

i. The unique NE is (w1 , f1 ) = (0, 1100) and (w2 , f2 ) = (1600, 0). This strategy-profile
is a NE since each strategy is a best-response to the other. To establish uniqueness,
it suffices to show that the game is dominance-solvable and this is the unique profile
surviving iterated elimination of strictly dominated strategies. To see this, perform
the following iterative procedure (note that this actually also constitutes a proof
that this is the unique NE):
Step 1: Eliminate for each player i any (wi , fi ) >> 0 .
Step 2-a: Eliminate for player 2 any strategy (0, f2 ) with f2 > 1100 ".
Step 2-b: Given step 2-a, eliminate for player 1 any strategy (w1 , 0) with w1 >
1600 ".
REPEAT STEPS 2-a AND 2-b (now with k" for k = 2, 3, ...) UNTIL ALL STRATEGIES FOR PLAYER 2 WITH f2 > 0 HAVE BEEN ELIMINATED AND ALL
STRATEGIES FOR PLAYER 1 WITH w1 > 500.
Step 3-a: Given the above eliminations, eliminate for player 2 any (w2 , 0) with w2 <
".
Step 3-b: Given step 3-a, eliminate for player 1 any (w1 , 0) with w1 > 500 ".
REPEAT STEPS 3-a AND 3-b (now with k" for k = 2, 3, ...) UNTIL ALL STRATEGIES FOR PLAYER 1 WITH w1 > 0 HAVE BEEN ELIMINATED AND ALL
STRATEGIES FOR PLAYER 2 WITH w2 < 500 + " HAVE BEEN ELIMINATED.
Step 4-a: Eliminate for player 1 any (0, f1 ) with f1 < ".
Step 4-b: Given step 4-a, eliminate for player 2 any (w2 , 0) with w2 < 500 + 2".
REPEAT STEPS 4-a and 4-b (now with k" for player 1 and (k + 1)" for player
2 for k = 2, 3, ...) UNTIL ONLY THE STRATEGIES (w1 , f1 ) = (0, 1100) and
(w2 , f2 ) = (1600, 0) are left.
ii. For each positive " > 0, the equilibrium remains unchanged since it does not depend on the particular value of ". The limit of the equilibria [(w1 , f1 ), (w2 , f2 )] =
[(0, 1100), (1600, 0)] as " & 0 is an equilibrium when " = 0 (i.e., in part (a)). Therefore, the correspondence in question is upper hemicontinuous.

a) A strategy for a politician with quality q is a choice from the set {In, Out}, where In
signifies that he enters the election, and Out signifies that he does not.
b)

i. An entrant of quality q 0 earns q by staying out, and 12 q+ 12 (q 0 +s) k = 12 (q+q 0 +s) k

from entering. Thus, we must have
1
(q + q 0 + s)
2

q
7

or
q0

q + s 2k

Because this statement must be true for all q 0 2 [0, 1], we have
1

q + s 2k

or
2k + s

(1)

No further conditions must be met to have a single candidate equilibrium. We do

not have to worry about the single candidates incentives because he has no incentive
to deviate by not entering, given that the consequences are anarchy with a payo
of 1.
ii. Plainly, if (1) is satisfied for any q, it is also satisfied for q = 1. Thus, a singlecandidate equilibrium exists i
1

2k + s

or

k
1
s
2
iii. The best single-candidate equilibrium always involves quality q = 1, and is therefore
unaected by s and k. The worst single-candidate equilibrium is given by
q=1

2k + s

Therefore, an increase in compensation, s, improves the down-side, while an increase

in the costs of running for office, k, makes the down-side worse.
c)

i. An entrant of quality q 0 earns q by staying out, and

entering. Thus, we must have

N
N +1 q

N
1
q+
(q 0 + s)
N +1
N +1

1
0
N +1 (q

+ s)

k from

or
q0

q + s (N + 1)k

Because this statement must be true for all q 0 2 [0, 1], we have
1

q + s (N + 1)k

or
(N + 1)k + s

(2)

ii. Let q be the average quality of all the candidates, and q 00 be the average quality
of the remaining candidates if a candidate of quality q 0 drops out. A candidate of
quality q 0 receives a payo of q 00 if he drops out, and a payo of
1

N
N

q 00 +

1 0
(q + s)
N

if he runs. Thus, he is willing to run i

1

N
N

q 00 +
8

1 0
(q + s)
N

q 00

or
q0
Clearly, q =

N 1 00
N q

1 0
Nq .

q 00 + s

Nk

Therefore,
N

q 00 =

q0,

from which we infer that the candidate is willing to run i

N

q0

or
q0

q+

q+

1
1

q0 + s

Nk

s (N 1)k
N
That inequality plainly holds for all candidates i it holds for qmin . So we have
q+

qmin

N
N

(N

1)k

(3)

iii. Plainly, there exists a set of N candidates satisfying (3) with average quality q if
and only if such a set also exists for qmin = q (so that all candidates are of the same
quality). But in that case, the condition becomes simply
k
1

s
N
In other words, if ks N1 , then for any q we can find a group of N candidates
satisfying (3). Now we consider (2). Clearly, (2) is satisfied for some q i it is
satisfied for q = 1. Thus, to have an N -candidate equilibrium, we also require
1

(N + 1)k + s

or

k
1
s
N +1
Thus, the necessary and sufficient condition for the existence of an N -candidate
equilibrium is
1
k
1
(4)
N
s
N +1
1
d) Clearly, either ks
2 , in which case a single-candidate equilibrium exists, or there exists
1
k
1
N 2 such that N
s
N +1 , in which case an N -candidate equilibrium exists. Thus
we have existence, and we see that the number of candidates rises as ks falls. When
k
1
1 candidates; otherwise,
s = N for any N , there exist equilibria with both N and N
the number of candidates is unique.

e) From (4), it is obvious that N ! 1 as k ! 0 and as s ! 1.

Next consider the eect of k ! 0 on the range of quality. From the preceding analysis,
it is clear that there is always an equilibrium with q = 1. We know from (2) that
q 1 (N + 1)k + s, and we know from (4) that N ks . Thus,
s

q
1
+1 k+s
k
= 1 k
9

Thus, q ! 1 as k ! 0: reducing entry costs is unambiguously beneficial in the limit.

Finally consider the eect of s ! 1 on the range of quality. Again, there is always
an equilibrium with q = 1. As ks declines from N1 to N 1+1 , the lowest quality in an
N -candidate equilibrium increases. So lets focus on bad equilibria when ks = N1 (the
worst of the worst). In that case, (2) becomes
1

(N + 1)k + s

= 1

Thus, as s gets large with k fixed, quality does not converge to 1. Instead, the lowest
quality is a saw tooth function of s, and at each tooth it falls to 1 k, no matter
how large s becomes. We conclude that very low k promotes the quality of governance,
while very high s does not.
15. We dont need to consider strategies eliminated by ISD2 . Thus, we consider the reduced 3 3
game:
b
c
e
A 4, 2 1, 0 2, 4
C 0, 0 3, 3 0, 1
D 2, 4 0, 0 4, 2
First note that the unique PSNE (C, c) is a special case of a MSE.
Second, note that neither player has two pure best responses to any opponents pure strategy,
so there will be no pure/mixed equilibria.
We now look for equilibria where each player mixes over all 3 strategies:
Player 1
A
1
C
2
D (1
1

Player 2
b
1
c
2
e (1 1 2 )

2)

We pin down 1 and 2 by requiring that 1(!) be indierent between A, C and D.

U1 (A) = 41 + 2 + 2(1
U1 (C) =
32
U1 (D) = 21
+ 4(1
Equating these three yields 1 =

1
11 , 2

2 )

2 ).

6
11 .

Analogously, requiring 2s indierence yields

1
11 ,

6
11 .

1 6 4
1 6 4
Thus, we have the MSE ( 11
, 11 , 11 ), ( 11
, 11 , 11 ).

Now we look for mixed strategies in which at least one player plays only 2 strategies. Note
the following (using dominance against the strategies in question):
If 1 plays A and C only, 2 will only play c or e;
if 1 plays C and D only, 2 will only play b or c;
if 1 plays A and D only, 2 will only play b or e.
Similarly:
2

Iterative deletion of Strictly Dominated strategies

10

If 2 plays b and c only, 1 will only play A or C;

if 2 plays c and e only, 1 will only play C or D;
if 2 plays e and b only, 1 will only play A or D.
From this, we can rule out any 2 3 MSE. We also see that the only potential 2 2 MSE are
of the form A + (1
)D, b + (1 )e.
Using the same technique as in the 3 3 case, we find =

= 21 .

Thus, we have a third and final MSE: ( 12 , 0, 12 ), ( 12 , 0, 12 ).

16.

a) Is there a PSNE involving A? Then 2 must best respond and play b. But then 1 must
play B.
Is there a PSNE involving B? Then 2 must best respond and play a. But then 1 must
play A.
This rules out all PSNE.
b) At a MSNE, players must be indierent between playing all strategies in the support of
the mixture. Routine calculation shows that for indierence to hold, player 1 must play
y m
x z
A with probability x z+n
v and player 2 must play a with probability y m+u w .

17. We resolve indierence for consumers facing p = v by assuming the consumer buys.3
No PSNE
Observe first that naming price p = v guarantees at least the residual demand Q (N 1)K
and thus payo (Q (N 1)K)v > 0. Naming p > v guarantees payo 0. Thus, we rule out
all p > v.
There are two cases to consider: everyone charges the same price, or not everyone charges
the same price.
Q
Case 1: p1 = p2 = . . . = pN = p 2 (0, v]. Here equilibrium payo is p N
for each firm. But
Q
Q
then any firm can deviate to p ", secure market share K > N
, and earn payo (p ")K > p N
for small enough ".

Case 2: Let pL and pH be the lowest and highest prices named in equilibrium with pL < pH .
But then a firm naming pL could deviate to pH ", maintaining a market share of K, and
earn payo (pH ")K > pL K small enough ".
Thus, we have no PSNE.
Finding the Symmetric MSE
We look for a symmetric MSE represented by distribution function F () where the support is
given by [p, v] with p > 0.4

3
4

Let the (expected) equilibrium payo be given by . Suppose players j 6= i are mixing using
F (). Then for i to be mixing over [p, v], i must be indierent over every price in this range.
Observe that by naming p 2 [p, v], with probability F (p)N 1 , is price will be the highest and
he will secure residual market share Q (N 1)K. With probability 1 F (p)N 1 , is price
will not be the highest and he will secure residual market share K. Thus, expected payo
from naming p is given by

(p) = p F (p)N 1 (Q (N 1)K) + (1 F (p)N 1 )K = .

(5)

The problem can also be solved with any other assumption

The proof that this is the unique symmetric MSE is a simple extension of the 2 firm case in the notes.

11

We pin down by noting F (v) = 1 ) (v) = v(Q

(N

Now we can solve equation (5) for F (p) to find

(Q (N 1)K)v
F (p) =
(Q (N 1)K)p

1)K) = .

pK
pK

Finally, we pin down p by noting that F (p) = 0 ) p =

1
N

(Q (N 1)K)
v.
K

That completes our characterization of the symmetric MSE.

Comparative Statics
Suppose we let N get large, adjusting K (lower) so that the assumptions hold. Observe that
p = (Q (NK 1)K) v, where the coefficient on v is given by the ratio of residual demand to K.
Thus, even for large N , we can have p lie anywhere in the range (0, v).
However, observe that F (p) ! 1 for all p 2 [p, v], so that the equilibrium approaches the
PSNE where all firms name p. Thus, the limiting case depends crucially on how we adjust K
as N gets large.
18.

a)
b) The normal form of the game is given by
aa
an
na
nn

r
0, 2
3, 2
3, 10
0, 10

y
10, 0
5, 5
5, 5
0, 10

d
-100,-100
-50,-45
-50,-45
0,10

c) The unique PSNE is (nn, d).

To calculate the mixed strategy Nash equilibria, observe that although no strategies are
strictly dominated, d is weakly dominated for B. We exploit this fact.
Consider NE in which A places positive probability on aa, an or na (ie any strategy
other than all weight on nn.) In such a NE, we observe that B cannot be placing any
probability on d. It follows that nn is strictly dominated by an and that na is strictly
dominated by a mixture of aa and an. Thus, we have a reduced 2x2 matrix. Solving for
the mixed NE in the standard way yields ( 35 , 25 , 0, 0), ( 58 , 38 , 0).
Now consider NE in which A places all probability on nn. That is, A uses the pure
strategy nn. Any strategy B for B is a best response to this. Therefore, we need
restrictions on Bs strategy such that nn is a best response to B .
Let r , y , d represent the weights on r, y and d in B , where r = 1
y
d.
A (aa) A (nn) )
A (an) A (nn) )
A (an) A (nn) )

3
3

r
r

+
+

10
5
5

y
y
y

100
50
50

d
d
d

0
0
0

Observe that if the middle inequality is satisfied, then so too are the first and third. Thus,
we have NE (0, 0, 0, 1), (1 y
d , y , d ) for all y , d 2 [0, 1] satisfying 3+2 y 53 d
0 and y + d 1.
19.

a) Observe that since it is not immediately obvious what player 1 might play, LL, L and
R are very risky, yielding very small gains if you guess right, and significant losses if
you guess wrong. Thus, only M seems reasonable.
12

b) The PSNE are (U, LL) and (D, R). The only non-pure MSE is given by ( 51
52 U +
1
1
1
52 D, 2 LL + 2 L).
To see this, observe that since no player has multiple best responses to any opponents
pure strategy, there are no pure/mixed NE.
Any potential 23 or 24 MSE can be ruled out because requiring indierence between
> 2 strategies for player 2 yields an insoluble system with more equations than variables.
The 2 2 cases must be analyzed individually.
c) M is not a part of any of the above strategies. M is, however, rationalizable. One way
to see this is that no strategies can be removed by ISD.

d) With preplay communication, players could agree on one of the NE. The self-enforcing
nature of NE would make this agreement credible. The PSNE are payo equivalent and
pareto dominate the 2 2 MSE, so we would expect agreement on either of these.
20.

a) There is no PSNE. There are three configurations to consider:

i. Both firms quote a price: optimality implies that they must quote the same price
(otherwise the payo for the one quoting the higher price would be k, and a
deviation to no price quote would increase its payo). Moreover, this price p
must be at least c + 2k (otherwise each would earn (p c)/2 k < 0, in which
case a deviation to no price quote would increase its payo). But then either
firm could increase its profit by slightly undercutting p (earning nearly p c k >
(p c)/2 k 0).
ii. Only one firm quotes a price. In that case, the quoted price must be v (otherwise
the quoting firm could increase its profits by deviating to a higher price). But
then the other firm, which earns zero, could obtain a strictly positive payo (nearly
v c k > 0) by quoting a price slightly below v.
iii. Neither firm quotes a price. In that case, a deviation to pi = v would yield a payo
of v c k > 0, instead of 0.
b) In a mixed strategy equilibrium, a player must be indierent between all sets of strategies
selected with strictly positive probability. Here, a firm quotes no price with strictly
positive probability. When this occurs, its payo is zero; hence the equilibrium expected
payo is zero. When a firm names a price less than c + k or greater than v, its payo
is strictly negative. It cannot be indierent between this and no price quote (which
yields a payo of zero). Consequently, it cant make both of these choices in an MSE.
The probability that the other firm quotes price lower than p is F (p), so the firm makes
the sale with probability 1 F (p). In that case, it earns profits p c. Since it incurs the
cost k regardless of whether it makes the sale, its expected payo is (1 F (p)) (p c) k.
In light of this, for any
price inthe support of F we must have (1 F (p)) (p c) k = 0.
1 p c k
This implies F (p) =
. Notice that this is non-negative and strictly increasing
p c
on [c + k, v], with F (c + k) = 0. Since the support of F is the entire interval [c + k, v],
we choose so that F (v) = 1. This implies = v v c c k . So F is flat up to c + k, strictly
increasing between c + k and v, and flat beyond v.

21.

a) Strictly positive profits. A firm not earning strictly positive profits could gain simply by
setting its price equal to v (since it would sell to the loyal customers).
b) No, there isnt a PSNE for this game. We know both firms earn strictly positive profits,
which means both must quote prices in (c, v]. If the prices are dierent, the firm with
13

the lower price could gain by increasing it. If the prices are the same, either firm could
gain by slightly undercutting the other.
c) When quoting p, the expected payo is (p c) [K + (1 F (p))N ]. Setting the expression
payo equal to a constant, C, and solving, we get: F(p) =
for expected

v p
K C/K (p c)
1 N
. Using F (v) = 1 gives us C/K = v c, so F (p) = 1 K
p c
N
p c .
00
00
Note that this equals zero when p = NNc+Kv
+K = p . Obviously, p 2 (c, v). So F equals
00
zero up to p (which exceeds costs), and then increases continuously, reaching a value of
00
unity at p = v. As K
N ! 0, p ! c, and F (p) ! 1 for all p > c, so we have convergence
00
to the standard Bertrand outcome. As K
N ! 1, p ! v, and F (p) ! 0 for all p < c, so
we have convergence to the monopoly outcome.

22. Let v1 = v and v2 = v 0 > v.

a) Any bid bi > vi for Bidder i is strictly dominated by a bid bi = 0. Removing these
strategies yields a game where bidding b2 > v is strictly dominated by bidding b2 = v for
Bidder 2, given the tie-breaking assumption (namely, since Bidder 2 wins in the event
of a tie, and Bidder 1 will not bid greater than v, there is no reason for Bidder 2 to do
so). All bids bi 2 [0, v] can be rationalized by some bid of the opponents, bj 2 [0, v],
and therefore, no other strategies can be removed by iterative elimination of strictly
dominated strategies.
b) There are no PSNE. To establish this, let us consider the following profiles (b1 , b2 ) 2
[0, v]2 to see whether there is a strictly profitable deviation:
b +b

i. bi < bj : Bidder j can improve her payos by decreasing her bid to i 2 j while
ensuring that she still wins the auction
ii. 0 < bi = bj : Then Bidder 2 wins the object for sure, and Bidder 1 can strictly
improve her payos by bidding 0 instead.
iii. bi = bj = 0: Then Bidder 1 loses the object for sure and can do strictly better by
bidding any b1 2 (0, v).

Observe that the preceding three cases exhaust the profiles in [0, v]2 . Since all other
profiles use strategies that are not rationalizable, this establishes that there are no PSNE.
c) By (a), all b1 > v are strictly dominated and so it could not be a best response to put
positive probability on (v, 1). Similarly, for bidder 2, b2 > v is iteratively dominated,
and so this too could not be part of a best response.
d)

i. If b2 = x, then regardless of whether she wins, Bidder 2 pays x. She wins if x b1 ,

and therefore, wins the object with probability F1 (x). Her expected payo from
bidding x is F1 (x) v 0 x.
ii. Observe that F1 (v) = 1. Therefore, from b2 = v, Bidder 2s expected payo is
v 0 v.
iii. Since Bidder 2 will mix according to F2 only if she is indierent between all strategies
in its support,
F1 (x) v 0

x = v0
v0
F1 (x) =

Observe that F1 (0) =

v0 v
v0 .

14

v
v+x
v0

iv. If Bidder 1 bids x, she wins if and only if b1 > b2 . Assuming that F2 is continuous
(we will verify this later), her payo from b1 = x is F2 (x) v x. Since Bidder 1
mixes over the interval [0, v], and F2 (v) = 1, her expected payo is 0.
v. From above
F2 (x) v

x = 0
x
F2 (x) =
v

Observe that F2 (0) = 0.

Rv
v2
e) E[b1 ] = 0 vx0 dx = 2v
0.
Rv x
v
E[b2 ] = 0 v dx = 2 .

v
v
0
0
Hence, expected revenue is 2v
0 + 2 and is decreasing in v ; since increases in v simply
serve to depress 1s bid but do not increase 2s bid, the expected revenue is strictly
decreasing in v 0 .

23.

a) It is strictly dominated to bid bi > v. No other strategies can be iteratively eliminated.

b) There are no PSNE.
i. Case 1: 0 bi < bj v. This cannot be an equilibrium because Student j
like to decrease his bribe slightly, thereby getting a payo of v bj + " > v
ii. Case 2: 0 bi = bj < v. This cannot be an equilibrium because Student j
like to increase his bribe slightly, thereby getting an expected payo of v
instead of 12 v bj .
iii. Case 3: bi = bj = v. This cannot be an equilibrium because Student j would
change his bribe to 0, thereby getting a payo of 0 rather than 12 v v < 0.

would
bj .
would
bj "
like to

c) No, since this would be strictly dominated.

d) F (bi ) v

bi

e) From (d), the payo from a bribe of v is F (v)v

v=0 because F (v) = 1 by assumption.

f) Student i must be indierent between all of the bribes he pays with positive probability.
Therefore, from (e), F (bi )v bi = 0 for all bi 2 [0, v] and F (bi ) = bvi .
Rv
g) The Social Chair expects to make 2 0 vb db = v.
h) The payo from a bribe bi < b0 is (1 ) G (bi ) v bi . The payo from a bribe b is

+ (1 ) v b.
2

i) When bi = 0, is payo is 0 because G(0) = 0 by assumption.

j) Again, Student i must be indierent between all of the bribes he pays with positive
2(v b)
probability. So 2 + (1 ) v b = 0 ) = v . Also, (1 ) G (bi ) v bi = 0 )
G(bi ) = (1 bi)v = 2bbi v . We know G(b0 ) = 1 ) b0 = 2b v.

k) The Social Chair expects to make

!Z
!
2b v
2 v b
2 v b
b
2
1
db +
b
=
v
v
2b v
0
=

2b

1 2
4b
v

2b

v
v

b b

4 v

4bv + v 2 + 4bv

Therefore, the spending cap left the total amount of bribing unchanged.
15

v
4b2 = v

24.

a) The pure strategy set is the interval [0, bmax ]. A mixed strategy is a CDF on that interval specifically, a monotonically increasing uppersemicontinuous (right-continuous)
function F with F (0) 0 and F (bmax ) = 1. The mixed strategy set is the set of all such
functions.
b) There is no pure strategy equilibrium. If there is a single high bidder, the winner could
lower his bid. If there is more than one high bidder below the upper bound, then either
player would benefit from increasing his bid slightly. If there is more than one bidder at
the upper bound, each has a negative expected payo (since the upper bound is above
5) and would benefit from changing his bid to 0.
c) We need to solve for F , , and b0 . Because F is atomless, the probability of winning,
and hence the expected payo, when bidding 0 is 0. Because 0 is in the support of F ,
the equilibrium expected payo is zero by the mixed strategy indierence condition. A
bid at the cap (bmax ) earns:
h
i
+ (1 ) 10 bmax .
2
Setting that expression equal to zero (the equilibrium expected payo), we see that
=
A bid of b0 earns:

(1

10

bmax
.
5
b0 .

)10

Setting that expression equal to zero (the equilibrium expected payo) and substituting
for , we see that
b0 = 2bmax 10.
A bid of b 2 [0, b0 ] earns:

(1

)F (b)10

b.

Setting that expression equal to zero (the equilibrium expected payo) and substituting
for , we see that
b
F (b) =
.
2bmax 10
To verify that the solution is a mixed strategy equilibrium, we need to check that a
player cannot gain by deviating to a bid outside the support of F . The complement of
the support of F is b 2 (b0 , bmax ). For all such b, the expected payo is:
(1

)10

b (1

)10

b0 = 0.

d) The case of no bid cap is equivalent to bmax = 10, so it is a special case of the above.
As weve shown, the expected payo for each student is zero regardless of bmax . For this
game, the payos of all players sum to 0 in every realization (and hence in expectation),
so Bernheims expected payo is also 0. This means his expected revenue must be
10 (just enough to compensate for the $10 bill) irrespective of bmax . Intuitively, the
students will always compete away all positive rents, if not by bidding close to 10, then
by matching each other with the maximum bid.

16

25.

a) The pure strategy set is the set [bmin , 1] [ { }. A mixed strategy is a probability
of playing , plus a CDF F (b) on [bmin , 1] that governs choice with probability 1
. Specifically, F is a monotonically increasing uppersemicontinuous (right-continuous)
function F with F (b) = 0 for b < bmin and limb!1 F (b) = 1. The mixed strategy set is
the set of all such functions.
b) There is no pure strategy equilibrium.
Case 1: There is only one active bidder. Either that bidder bids less than $10, in which
case another student would have an incentive to bid higher, or he bids $10, in which
case he has an incentive to lower his bid.
Case 2: There are at least two active bidders. If there is only one high bidder, he
must be bidding more than bmin and has the incentive and opportunity to lower his bid.
If there is more than one high bidder below $10, then any one of them would benefit
from increasing his bid slightly. If more than one bidder ties at $10, each has a negative
expected payo, so a deviation to is better.
c) Assume F has an atom at bmin . Then a players probability of winning (and hence his
expected payo) rises discontinuously when increasing his bid from bmin to bmin + ", a
contradiction. Now assume F has an atom at 10. Then a player receives a negative
expected payo from playing 10, and could improve his expected payo by shifting that
atom to .
d) In light of part (3), the probability of winning when bidding 10 is unity; hence the
expected payo when bidding 10 is 0. Because 10 is in the support of F , the equilibrium
expected payo is zero by the mixed strategy indierence condition.
A bid at the floor earns an expected payo of:
10

bmin

Setting that expression equal to zero (the equilibrium expected payo), we see that
=

bmin
10

A bid of b earns:
10 [ + (1

)F (b)]

Setting that expression equal to zero (the equilibrium expected payo), we see that

1
b
F (b) =

1 10
Substituting for , we obtain
F (b) =

b bmin
10 bmin

To verify that the solution is a mixed strategy equilibrium with the desired properties,
we need to check that F (b) is a legitimate atomless CDF on [bmin , 10]. Substituting into
the above expression for F , we see that F (bmin ) = 0 and F (10) = 1, as required; we
also see that F 0 (b) = 10 1bmin > 0, also as required. We do not have to check deviations
outside the support of F (because there are none), and we have already assured (by
construction) that a player receives the same expected payo from as well as from all
b in the support of F . Thus we have a mixed strategy equilibrium.
17

e) The case of no bid floor is equivalent to bmin = 0, so it is a special case of the above.
As weve shown, the expected payo for each student is zero regardless of bmin . For this
game, the payos of all players sum to 0 in every realization (and hence in expectation),
so Bernheims expected payo is also 0. This means his expected revenue must be 10
(just enough to compensate for the $10 bill) irrespective of bmin . Intuitively, the students
will always compete away all positive rents with bmin = 0, and setting a higher minimum
will only cause them to compete less aggressively by opting out.
26.

a) Using iterative deletion, we find that 3 must play A and 2 must play L. There are 2
PSNE: (U, L, A) and (D, L, A).
b) No.
c) (U, L, A) is trembling hand perfect, but (D, L, A) is not.
To show this, we note that in this problem, "-constrained equilibria must take a particular
form: Note that because A is a dominant strategy for 3, in any "-constrained equilibrium,
3 must be placing no more that the required " weight on B. Similarly, 2 must be placing
no more than " on R. But then
1 (U ) = (1 ")2 1 + (1 ")" 1 + (1 ")" 1 + "2 0 and
1 (D) = (1 ")2 1 + (1 ")" 0 + (1 ")" 0 + "2 1
so that 1 (U ) > 1 (D). Therefore, 1 must be placing no more than the required " weight
on D.
Thus, for "n ! 0, we have a sequence of "-constrained equilibria that converges to
(U, L, A):
n

= ((1

"n )U + "n D, (1

"n )L + "n R, (1

"n )A + "n B).

Thus, (U, L, A) is trembling hand perfect.

On the other hand, since all "-constrained equilibria take this form, it is impossible to
find a sequence of "-constrained equilibria converging to (D, L, A), so (D, L, A) is not
trembling hand perfect.
Moral: In 3+ player games, the trembling-hand refinement can rule out more than just
NE where one strategy is weakly dominated. (In 2 player games, these two refinements
are equivalent.) Ask yourself what happened here that couldnt in a 2 player setting.
27. The unique profile surviving ISD is (C, c), which is a Nash equilibrium. Therefore, it is also a
correlated equilibrium. On the other hand, it is easy to show that no pure strategy eliminated
by ISD can be a part of a correlated equilibrium. It follows that (C, c) is the unique correlated
equilibrium.
28.

a) The NE are (B, L), (T, R) and ( 23 T + 13 B, 23 L+ 13 R). Thus, the set of payos is (7, 2) , (2, 7) ,
b) The convex hull of the payos is drawn below:

18

14 14
3 , 3

(2,7)

(14/3,14/3)

(7,2)

c) Lets look for payos outside the convex hull in (b) within the class of equilibria described
in the notes. (Of course, these are not the only correlated equilibria. But if we find one
outside of the convex hull, then we are done.)
L

R
(1

T
B (1

)/2

)/2
0

The symmetry of this class makes verification easy. We only need to verify that 1 would
agree to this distribution of outcomes. If 1 is told to play B , he believes that 2 will
play L with certainty, in which case B is in fact a best response. If 1 is told to play T ,
2
then he believes that 2 will play L with probability + 1 = 1+
and R with probability
2

2
1
2

1
1+

. For T to in fact be a best response, we require 1 (T )

6

2
1+

+2

1
1+

2
1+

1 (B) or

which reduces to 12 . Thus, when 12 , the distribution over outcomes described

above is a correlated equilibrium. Choosing = 12 yields the highest payo equilibrium
in this class, with payos (5 14 , 5 14 ). This falls outside the convex hull of the NE.
29. Here a strategy is a mapping si : {1, 2, . . . , M } ! {trade, not-trade}.

Mixed strategy NE: Observe that in no equilibrium will i use a strategy placing positive
probability on trading M . Suppose the contrary, that there exists an equilibrium s in which
play i places positive probability on trading M . Player is strategy can be a best response
only if all the other players use strategies in which 1, . . . , (M 1) are never traded. However,
this cannot be the case in a NE because player j 6= i would do better to deviate to the strategy
trade only when card reads 1.
19

Iterating this proof rules out placing positive probability on any number 2 through M 1.
Thus, the set of candidate strategies is reduced to si (1) = trade with probability p and
si (m) = not-trade with probability 1 for all m = 2, . . . , M .
It is easy to check that any profile where each i uses a strategy of this form is in fact a NE.
We can not use iterative deletion here. No strategy is strictly dominated. To see this, note
that if j 6= i all use the strategy never trade, then all strategies for i yield identical payos.

Correlated NE: An M is never traded in a correlated equilibrium. Suppose, towards contradiction, that there is a correlated equilbrium in which the correlation device assigns a positive
probability to player i using a strategy that involves trading an M . Suppose the state of the
world is such that the correlation device suggests using such strategy to player i. In order
for him to follow the suggestion in equilibrium, it must be the case that all other players
are instructed, by the correlation device, in such state of the world, to place zero probability
on any strategy that involves trading anything other than an M . But then, in this state of
the world, any j 6= i will have an incentive to deviate to the strategy that trades a 1 with
probability 1, and everything else with probability zero, a contradiction.
Repeating this argument rules out trading 2 through M in a correlated equilibrium. We
are left with the set of correlation devices that that assign probability zero to any strategy
involving trading any card greater than 1, all of which are easily verified to be correlated
equilibria.
Remark : For pedagogical purposes, we separated the 2 cases, but in fact the NE result follows
from the correlated equilibrium result.
30. We can calculate the normal form:
aa

an

aa

M 2w 2s M 2w 2s
,
4
4

2M w s M 2s
, 4
4

an

M 2s 2M w s
4 ,
4

M s M s
4 , 4

2M s M w
4 , 4

2M
4 ,0

M w 2M s
4 ,
4

M w M w
4 , 4

2M
4 ,0

0, 2M
4

0, 2M
4

0, 0

na
nn

2w 3M w s
4 ,
4

0, M

na
3M w s
,
4

nn
2w
4

M, 0

It is easily verified that the squares marked with an can never be NE for any M, s, and w
that satisfy the given conditions.
aa an na nn
aa

an

na
nn

For the remaining squares, verifying the conditions for a NE yields:
(aa, an) and (an, aa) are NE when M

2s and M > w;

(an, an) is a NE when M 2 (s, w);

20

(aa, nn) and (nn, aa) are NE when M 2s.

Finally, the NE of this game correspond to Bayesian Nash equilibria of the associated Bayesian
game.
31. To avoid confusion with quantity, we replace the probability q in the problem with . Inverse
demand is given by p(Q) = a bQ.
A BNE involves firm i choosing a quantity qci when its costs are c and a quantity qdi when
costs are d. For this to be a BNE, is choices of q must be optimal, taking js strategy as
given:
qci 2 arg max [a b(qcj + q) c)]q + (1 ) [a b(qdj + q) c)]q
q

qdi 2 arg max [a

b(qcj + q)

d)]q + (1

) [a

b(qdj + q)

d)]q

This yields FOCS:

qci

b(qcj + (1
2b

)qdj )

and

qdi

b(qcj + (1
2b

)qdj )

The symmetry of the problem implies qci = qcj = qc and qdi = qdj = qd . Solving the two FOCs
simultaneously for qc and qd yields
qc =
32.

1
2 (c

d)

and

3b

qd =

2 (d

3b

c)

a) A BNE where the project does not go forward definitely: 2 students play n regardless
of their type, and the rest of the students do anything. Then everyone gets a payo of
zero, and no deviation improves this.
A BNE where the project goes forward with positive probability: each student contributes i his valuation is greater than or equal to 10. Aside from resolving indierence
dierently when the students valuation is exactly 10, there is no other equilibrium of
this type. If the probability that everyone else plays y is strictly positive, then a student
will definitely choose y if his valuation is greater than 10, and definitely choose n if it is
less than 10.
b)

i. Once again, if both students choose n regardless of their valuations, this will lead
to a BNE where the project never goes forward.
ii. Claim: In every BNE, students will use a cuto strategy: i (vi ) = y if vi ci and
i (vi ) = n if vi < ci for some cuto ci .
Proof : In any equilibrium, there is some probability p i that student i chooses
y. Student i benefits from making a contribution i p i vi 10. For p i > 0, this
means setting a cuto ci = p10i is optimal. For p i = 0, setting ci > 45 is optimal.
ci
Let student i use cuto ci . Then the probability that i plays y is 1 45
; therefore cj =
10
450
2
= 45 ci . At a symmetric equilibrium, ci = cj = c, and hence c 45c+450 = 0.
c
1 i
45

This leads to c 2 {15, 30}. Consequently, there are two symmetric equilibria: one
where both students use 15 as a cuto, and the other where both use 30 as a cuto.
iii. At an asymmetric equilibrium, we would have c1 (45 c2 ) = 450 = c2 (45 c1 ).
This yields c1 = c2 . Therefore, there are no asymmetric equilibria.
c)

i. As before, there is a BNE where the project never goes forward if all students choose
n regardless of their valuations.
21

ii. In every BNE, students still must use a cuto strategy. This follows from the
argument in part (b), treating p i as the probability that all other students choose
y. At a symmetric BNE (if it exists), all students use the same cuto c. The
c N 1
probability that all other students choose y is 1 45
, so the best cuto to
10
.
This
means
that
any
symmetric
equilibrium has
use in response is c0 =
N 1
(1 45c )
c N 1
a cuto that solves c 1 45
= 10. For a project to go forward with positive
probability, we must have c < 45. We now show that this is impossible if N 3.
c N 1
Let f (c, N ) = c 1 45
. Let c (N ) = arg maxc2[0,45] f (c, N ). The FOC yields

c N
45

c
(N
45

1) 1

c N
45

= 0.

Since for c
45, f (c, N ) 0, and for c < 45, f (c, N ) > 0, we can verify that
c (N ) = 45
(you
can verify that this is the maximum without checking the 2nd
N
df
order condition by simply checking that for c < c (N ), dc
> 0, and for c > c (N ),
df
dc < 0).
N

Now, let g (N ) = f (c (N ) , N ) = 45(NN N1)

. Recognize that g (3) = 20
3 < 10.
Thus, there is no symmetric equilibrium where the project goes forward with positive
probability with 3 agents.
For N > 3, note that
dg
(N 1)N
= 45
dN
NN

(log (N

1)

log (N )) < 0.

Therefore, for every N

3, g (N ) g (3) < 10, and hence, the unique symmetric
equilibrium is the one where the project never goes forward.
33.

a) Each i has a dominant strategy: Name the highest xi , namely xi = 1, regardless of type.
Thus, we have a unique BNE in which each i names xi = 1 regardless of type.
b) This maximization problem is
max

x1 ,x2 2[0,1]

which has solution x1 =

2 , x2

x22
1
2

x1

+ x2

x21
2 ,
2

1
1 .

c) Method 1: We use the Groves mechanism described in the notes. Note that while
this implementation guarantees that truth-telling is a dominant strategy, it does not
guarantee budget balance. So well have to check specifically if we can achieve budget
balance in this case.
The Groves mechanism calls for:
1
2A
1
x2 (1A , 2A ) = x2 (1A , 2A ) = A
1
x1 (1A , 2A ) = x1 (1A , 2A ) =

Hence Ti 1A , 2A = Uj x1 1A , 2A , x2 1A , 2A , jA +Ki jA =
22

1
iA

1
2jA

+Ki jA .

Budget balance requires T1 (1A , 2A ) + T2 (1A , 2A ) = 0 8(1A , 2A ), so

1
1A

1
1
+ K1 (2A ) + K2 (1A ) + A
A
22
2

1
= 0.
21A

The simplest choices for K1 , K2 that satisfy this are

K1 (2A ) =
This leads to T1 1A , 2A =

1
1A

1
2A

1
22A
=

K2 (1A ) =

1
.
21A

T2 1A , 2A .

Method 2 We derive this from first principles. Consider a dierentiable directrevelation mechanism that implements the first best outcome with budget balance. We
assume that player 2 tells the truth. Let W (1 , , 2 ) represent the payos of player 1
when his true type is 1 , his announcement is type , and player 2s true type is 2 . I.e.,
W (1 , , 2 ) =

1
2

1
+ T1 (, 2 )
22

Since player 1 would want to maximize his payos, we take the FOC wrt :
dW
1
dT1 (, 2 )
= 3+
d

d
Since truth-telling must be a dominant strategy [as the mechanism satisfies incentive
compatibility conditions], it must be that for each 2 , dW
d |=1 = 0. Making the substitution implies that
dT1 (1 , 2 )
1
=
d
12
Integrating up, we obtain, T1 (1 , 2 ) = 11 + C1 (2 ). To establish budget balance, let
T1 (1 , 1 ) = 0. Hence, C1 (1 ) = 11 , and therefore letting C1 (x) = x1 assures budget
balance. Thus, using Ti (i , j ) = 1i 1j implements the optimal mechanism.
34. Let x denote the amount in Lilos box and y denote the amount in Tims box. The pair
of functions sL (x) = x, and sT (y) = y constitute a Bayes-Nash
eqm. Conditional on Tim
R 100
z+y
1
following this strategy, then Lilos problem is to choose z to maxz 0 100
1{z+yx+y} dy.
2
If z > x, then this expression is 0, and for all z < x, this expression is increasing in z.
Therefore, Lilo would not want to deviate from eqm strategies. The analysis is symmetric for
Tim.
35.

a) A pure strategy is a mapping from [0, 1] to R+ . An example: b(s) = s for any s 2 [0, 1].

b) An example: b(s) = 3 for any s 2 [0, 1] is weakly dominated by the strategy b(s) = 2
for any s 2 [0, 1]. It is not strictly dominated because when the other bidder bids
according to b(s) = 0 for any s 2 [0, 1] there is no other strategy that yields strictly
higher (expected) payo.

c) Suppose bidder 2 bids according to b2 (s2 ) = s2 . When observing signal s1 , bidder 1s

R b1
expected payo by bidding b1 is 0 (s1 + s2 s2 )ds2 if b1 (so that the upper limit
R1
of the integral does not exceed 1) and 0 (s1 + s2 s2 )ds2 if b1 . Note that in the
second case the payo does not depend on b1 .
23

d) Bidder 1s maximization problem is

max0b1

b1

(s1 + s2

s2 )ds2

Ignoring the b1 constraint, FOC yields b1 (s1 ) =

1 s1 .

e) Unlike in the example from the notes, the value of the item to one player is dependant
on the other players signal. If the other player bids is high, that suggests that the
value of the object is higher. Therefore, it is a best response to bid more than ones
own valuation.
f) Symmetry implies 1 = , therefore = 2. Now check when = 2, b1 (s1 ) = 2s1
= 2 for all s1 , therefore the inequality constraint is satisfied.
So a symmetric BNE is bi (si ) = 2si for i = 1, 2.
g) From the previous part, if bidder 1s strategy is b1 (s1 ) = s1 , bidder 2s best response is

if 1 s2
1 s2
b2 (s2 ) =
2 [, 1) if 1 s2
In particular, b2 (s2 ) = 1 s2 is a best response for bidder 2. Let = 1 , similarly we
can check that given b2 (s2 ) = s2 , bidder 1s best response is b1 (s1 ) = s1 .
Therefore, there exist a continuum of asymmetric equilibria, of the form b1 (s1 ) = s1
and b2 (s2 ) = s2 where = 1 , > 1.
h) In an equilibrium where b1 (s1 ) = s1 and b2 (s2 ) = 1 s2 , bidder 1 wins if and only if
s1 1 1 s2 .
If < 2, < 1 , i.e. bidder 1 is less aggressive than bidder 2. For any s1 , the expected
payo to bidder 1 is
Z ( 1)s1

1
1 (s1 ) =
(s1 + s2
s2 )ds2 = ( 1)s21
1
2
0
If > 2, > 1 , i.e. bidder 1 is more aggressive than bidder 2. For any s1 , the
expected payo to bidder 1 is
( R
( 1)s1
(s1 + s2 1 s2 )ds2 = 12 ( 1)s21 if s1
0
R1
1 (s1 ) =

1
if s1 >
1 s2 )ds2 = s1
0 (s1 + s2
2( 1)

1
1
1
1

1 (s1 ) is increasing in . A larger means bidder 1 is more aggressive in bidding. In

such an asymmetric equilibrium, the more aggressive is bidder 1, the less aggressive
bidder 2 is. And by being more aggressive bidder 1 increases his chance of winning and
reduces the payment upon winning.
36.

a) Yes there is; if every other individual discloses her grade, an individual is indierent
between disclosing her grade and not doing so since in either case, she would receive the
same marks.
b) Yes it is. If this student believes that all other students are disclosing their grades, she
is indierent between disclosing and not disclosing. As such, it is 1-rationalizable for
her to not disclose her grade. Since by (a), it is a NE for all students to disclose their
grades, it is rationalizable for all other students to disclose their grades. Therefore, it
is rationalizable for a student with 10 to not disclose her grade.
24

c) -d) Proving that there is no such mixed strategy equilibrium suffices to establish that
there is no such PSE in (c). Suppose by way of contradiction that there is some mixed
strategy equilibrium where an inidividual with a strictly positive grade does not disclose
her grade with positive probability. Let M > 0 be the highest grade that is not disclosed
in equilibrium with positive probability. Then all students with grades of 0 shall not
disclose their grades with probability 1 [since not disclosing their grades yields a positive
expected grade]. Therefore, any student with a grade M shall receive a grade strictly
less than M if she does not disclose her grade. Therefore, she would strictly prefer to
disclose her grade, leading to a contradiction.
37. This problem is a colossal pain. The technique is to use backward induction, carefully checking
all equilibrium outcomes in each subgame.
A strategy in this game is given by ((r, p, ), (q, )) where r is the probability E places on In,
p and q are the probabilities placed on Fight by E and I respectively, and and are the
probabilities placed on Here by E and I respectively. To simplify notation, if e.g. the entrant
plays F with probability 1 if In, we write ((r, F, ), (q, )) etc.
We first look at the final subgame:
H
T
H 3, 1 0, 0
T 0, 0 x, 3
Three cases:
x < 0 Here the game is dominance solvable. The unique eqm is (H, H), with outcome (3,1).
x = 0 Here we have a continuum of eqa characterized by ( , T ) where
sponding eqm outcomes (0, 3(1
)).

3
4

and corre-

x > 0 Here we have two pure strategy eqa, as well as a mixed strategy eqm: (H, H) yielding
3
outcome (3,1), (T, T ) yielding outcome (x, 3), and ( = 34 , = 3+x
) yielding outcome
3x 3
( 3+x , 4 ).
We now replace the H/T subgame with each of the outcomes above (backward induction).
In all three cases, (H, H) is an eqm, with outcome (3,1). Replacing the final subgame with
this outcome, the F/A subgame is reduced to:
F
A
3, 1 1, 2
2, 1 3, 1

F
A

This subgame is dominance solvable, with eqm (A, A) and outcome (3,1). Replacing this
subgame with its outcome, we find that the Entrant will choose In. Thus, 8x we have SPNE:
((In, A, H), (A, H)).

Case x = 0 The F/A subgame becomes

F
A

F
A
3, 1
1, 2
2, 1 0, 3(1
)
25

(6)

This game has a unique eqm a mixed strategy eqm given by (p = 45 33 , q = 12 ) with outcome
( 1, 1). It follows that E will play Out. Thus, when x = 0 we have SPNE

4 3
1
3
Out,
,
,
,T
for any .
(7)
5 3
2
4
Case x > 0, outcome = (x, 3) Now the F/A subgame becomes
F
A

F
A
3, 1 1, 2
2, 1 x, 3

Since x is in the normal form, we have subcases.

a) x > 1 Here the F/A subgame is dominance solvable. The eqm is (A, A), with outcome
(x, 3). It follows that E will play In. Thus, when x > 1, we have SPNE
((In, A, T ), (A, T )).

(8)

b) x = 1 Here we have a continuum of eqa given by (p, A) where p 45 , and corresponding

outcomes (1, 3 5p). For any outcome, E will play In. Thus, when x = 1, we have
SPNE
4
((In, p, T ), (A, T )) for any p .
(9)
5
c) x < 1 Here we have a unique eqm a mixed eqm given by (p = 45 , q = 12 xx ) with outcome
2
( 3x
2 x , 1). Whether this outcome beats the payo 0 choice of Out depends on x.
When x < 2/3 we have SPNE

4
1 x
Out, , T ,
,T
.
(10)
5
2 x
When x = 2/3 we have SPNE

4
1
r, , T ,
5
2
When x > 2/3 we have SPNE

x
,T
x

4
In, , T
5

for any r 2 [0, 1].

1
,
2

x
,T
x

3x 3
Case x > 0, outcome = ( 3+x
, 4 ) Now the F/A subgame becomes

F
A

F
3, 1
2, 1

A
1, 2
3x 3
3+x , 4

Since x is in the normal form, we again have subcases.

26

(11)

(12)

a) x > 32 Here the F/A subgame is dominance solvable. The eqm is (A, A), with outcome
3x 3
( 3+x
, 4 ). In this case, E will play In. Thus, when x > 32 we have SPNE

3
In, A,
4

, A,

x
3+x

(13)

7
b) x = 32 Here we have a continuum of eqa, given by (p, A) for p 11
, with corresponding
3 11p
outcomes (1, 4 ). For every outcome, E will play In. Thus, when x = 32 we have
SPNE

3
x
7
In, p,
, A,
for any p .
(14)
4
3+x
11
7
c) x < 32 Here we have a unique eqm a mixed eqm given by (p = 11
, q = 36 2x
x ) with
7x 6
outcome ( 6 x , 1). Whether this outcome beats the payo 0 choice of Out depends on
x.
When x < 6/7 we have SPNE

7 3
3 2x
x
Out, ,
,
,
.
(15)
11 4
6 x 3+x

When x = 6/7 we have SPNE

7 3
3 2x
x
r, ,
,
,
for any r 2 [0, 1].
11 4
6 x 3+x
When x > 6/7 we have SPNE

7 3
3 2x
x
In, ,
,
,
.
11 4
6 x 3+x
38.

a)

(16)

(17)

i. Si = {f or, against} for i = A, B, C.

ii. See attached.
iii. Here g() maps strategies to the triplet of payos where As payo is listed first, Bs
second and Cs third.
g(f, f, f ) = (1, 1, 1)
g(f, f, a) = (1, 1, 1)
g(f, a, f ) = (1, 1, 1)
g(f, a, a) = (0, 0, 0)

g(a, f, f ) = (1, 1, 1)
g(a, f, a) = (0, 0, 0)
g(a, a, f ) = (0, 0, 0)
g(a, a, a) = (0, 0, 0)

iv. The Nash equilibria are (f, f, f ), (f, f, a) and (a, a, a). The bill passes in the first
two equilibria.
v. Observe that for A and B, voting against the bill is weakly dominated. For C,
voting for the bill is weakly dominated. Thus, only in (f, f, a) does no player use a
weakly dominated strategy.
vi. There is no pure strategy SPNE. There are several ways to see this. One is to
reduce the game by replacing subgames with their equilibrium outcomes. There are
8 subgames: the game itself, and the subgames following completion of the show/no
show game. For the subgame following sss, there are two equilibrium outcomes:
(1 ", 1 ", 1 ") and ( ", ", "). For the subgame following ssn, there are also
27

two equilibrium outcomes: (1 ", 1 ", 1) and ( ", ", 0). Every other subgame
has a unique equilibrium outcome. Thus, there are 2 2 = 4 reduced games to
check. None of these has a pure strategy NE. (Although we know for sure that there
exists a mixed strategy NE!)
Another, perhaps simpler method is to rule out profiles case by case. Ask, is there
an equilibrium where as the entry component of their strategies A, B and C choose:
sss No. If following sss, an eqm where the bill passes is chosen, then C would do better
to not show up. If the no pass eqm is chosen in the subgame, then A or B would
have done better to not show up.
ssn No. Then A or B would do better by not showing up.
sns No. Then A would do better by not showing up.
snn No. Then C would do better by showing up.
nss No. Then B would do better by not showing up.
nsn No. Then C would do better by showing up.
nns No. Then C would do better by not showing up.
nnn No. Then A or B would do better by showing up.
b)

i. Si = {f or, against} for i = A, B, C.

ii. SA = {f,a}
SB = {,fa,af,aa}
SC = {,fa,af,aa,fa,fafa,faaf,faaa,af,aa,afaf,afaa,aa,aafa,aaaf,aaaa}
iii. Yes. This can be shown using backward induction, replacing each subgame with its
equilibrium outcome. One eqm is given by (f,,aaaa).
iv. No. Again, using backward induction to replace each subgame with its equilibrium
outcome, we find that the equilibrium outcome is that the bill passes.

39.

a) Since we are looking for SPE where voters vote sincerely, their actions are easily specified
at every information-set (they vote for the alternative they strictly prefer, and in the
case of indierence, can settle indierence any which way). As such, what one needs
to determine by backward induction is what the agenda-setter shall propose taking
into account that voters shall vote sincerely. The SPE outcomes are characterized for
each initial status quo.
Table 1
Status Quo Alternatives majority-preferred to status quo
Outcome
(0, 0, 0)
(0, 0, 0), (0, 1, 1), (1, 0, 1), (1, 1, 0), (1, 1, 1)
(0, 0, 0)
(0, 0, 1)
(0, 0, 0), (0, 0, 1), (1, 1, 0), (1, 1, 1)
(0, 0, 0)
(0, 1, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 1), (1, 1, 1)
(0, 0, 0)
(1, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0), (0, 1, 1), (1, 1, 1) (0, 0, 0)
(0, 1, 1)
(0, 0, 1), (0, 1, 0), (0, 1, 1)
(0, 0, 1)
(1, 0, 1)
(0, 0, 1), (1, 0, 0), (0, 1, 1), (1, 0, 1)
(0, 0, 1)
(1, 1, 0)
(0, 1, 0), (1, 0, 0), (0, 1, 1), (1, 0, 1), (1, 1, 0)
(0, 1, 0)
(1, 1, 1)
(0, 1, 1), (1, 0, 1), (1, 1, 0), (1, 1, 1)
(0, 1, 1)
b) From part A, we know that there are only four possible outcomes on the equilibrium
path: (0, 0, 0), (0, 0, 1), (0, 1, 0), and (0, 1, 1). In round 1, each z is associated with one
of these outcomes (in the sense that, if z becomes the status quo for the second round, it
will lead to the outcome indicated in the table 1). Consequently, the two round game is
28

just like a one round game where the possible choices are (0, 0, 0), (0, 0, 1), (0, 1, 0), and
(0, 1, 1). For this reduced form one round game, we can make up a table like table
Table 2
Status quo Possibilities
Outcome
(0, 0, 0)
(0, 0, 0), (0, 1, 1)
(0, 0, 0)
.
(0, 0, 1)
(0, 0, 0), (0, 0, 1)
(0, 0, 0)
(0, 1, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0) (0, 0, 0)
(0, 1, 1)
(0, 0, 1), (0, 1, 0), (0, 1, 1) (0, 0, 1)
Combining table 2 with table 1, we can make up the required table for the two round
game.
Table 3
Status Quo Outcome Proposal(s)
(0, 0, 0)
(0, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0)
(0, 0, 1)
(0, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0)
(0, 1, 0)
(0, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0)
(1, 0, 0)
(0, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0)
(0, 1, 1)
(0, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0)
(1, 0, 1)
(0, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0)
(1, 1, 0)
(0, 0, 0)
(0, 0, 0), (0, 0, 1), (0, 1, 0), (1, 0, 0)
(1, 1, 1)
(0, 0, 1)
(0, 1, 1), (1, 0, 1)
For example, consider the status quo (1, 0, 1). We know from table 1 that, if this
becomes the status quo for round 2, the outcome will be (0, 0, 1). From table 2, we see
that, in the reduced form one round game, (0, 0, 1) leads to the outcome (0, 0, 0), which
therefore appears in the outcome column of table 3. From table 1, we see that this
outcome is obtained if (0, 0, 0), (0, 0, 1), (0, 1, 0), or (1, 0, 0) becomes the status quo for
round 2. Consequently, the agenda setter can propose any of these alternatives in round
1.
c) From part B, we know that there are only two possible outcome: (0, 0, 0) and (0, 0, 1).
In round 1, each z is associated with one of these outcomes (in the sense that, if z
becomes the status quo for the second round, it will lead to the outcome indicated in
the table 3). Consequently, the three round game is just like a one round game where
the possible choices are (0, 0, 0) and (0, 0, 1). For this reduced from one round game,
we can make up a table like table 1.
Table 4
Status quo Possibilities
Outcome
(0, 0, 0)
(0, 0, 0)
(0, 0, 0)
(0, 0, 1)
(0, 0, 0), (0, 0, 1) (0, 0, 1)
Combining table 4 with table 3, we can make up the required table for the three round
game.

29

Table 5
Status Quo Outcome Proposal(s)
(0, 0, 0)
(0, 0, 0)
Anything but (1, 1, 1)
(0, 0, 1)
(0, 0, 0)
Anything but (1, 1, 1)
(0, 1, 0)
(0, 0, 0)
Anything but (1, 1, 1)
(1, 0, 0)
(0, 0, 0)
Anything but (1, 1, 1)
(0, 1, 1)
(0, 0, 0)
Anything but (1, 1, 1)
(1, 0, 1)
(0, 0, 0)
Anything but (1, 1, 1)
(1, 1, 0)
(0, 0, 0)
Anything but (1, 1, 1)
(1, 1, 1)
(0, 0, 0)
Anything but (1, 1, 1)
For example, consider the status quo (1, 0, 1). We know from table 3 that, if this
becomes the status quo for round 2, the outcome will be (0, 0, 0). From table 4, we see
that, in the reduced form one round game, (0, 0, 0) leads to the outcome (0, 0, 0), which
therefore appears in the outcome column of table 5. From table 3, we see that this
outcome is obtained if anything other than (1, 1, 1) becomes the status quo for round 2.
Consequently, the agenda setter can propose any of these alternatives in round 1.
d) True. From part C, the statement is true with three rounds. Moreover, with more
than three rounds, we know the outcome will be (0, 0, 0) regardless of the status quo
inherited by the third to last round. Therefore, all play before the third-to-last round
is irrelevant, as all status quos lead to the same outcome. If the agenda setter proposes
(0, 0, 0) in the first round, all legislators are willing to vote for it, even though they prefer
(1, 1, 1).
40. Recall that in an extensive form game, a (pure) strategy consists of an action taken at each
information set. In this game, information sets consist of monopoly nodes and duopoly nodes.
That is, in the extensive form, each player has exactly t + 1 time t information sets - one
duopoly node (no one exited in time 0 . . . t 1) and t monopoly nodes (opponent exited at
each time 0 . . . t 1).
Using backward induction on the subgames that begin with monopoly nodes, actions in
monopoly nodes are easily specified:
Firm A:
t = 1 . . . 19
t = 20
t > 20
Firm B:
t = 1 . . . 24
t = 25
t > 25
We now must

)
)
)

stay in
stay in, 1
out

out

) stay in
)
stay in, 1
out
) out
specify actions taken at duopoly nodes. Again we rely on backward induction.

In the duopoly subgame beginning at any t > 25, for each firm, any strategy specifying out
at time t strictly dominates any strategy specifying stay in. Thus, out is chosen by each
firm at each duopoly node with t > 25.
Consider the t = 25 duopoly subgame. For firm A, any strategy specifying out strictly
dominates any strategy specifying in, so A plays out at t = 25. Firm B mixes between
out and in.
Consider the t = 21 24 duopoly subgames. Here As dominant strategy is to exit immediately
regardless. It follows that B stays in and earns monopoly profits.
30

Consider the t = 20 duopoly subgame. Here we see that it is a dominant strategy for B to
play in, because in the continuation subgame, A will drop out in the next period and B
will reap 4 periods of monopoly profit. Thus, A must play out.
Consider the t = 11 19 duopoly subgames. For each t, it is a dominant strategy for B to
play in because (by backward induction) in the continuation subgame, A will drop out in
the next period. Thus A plays out.
Consider the t = 10 duopoly subgame. in is a dominant strategy for A because duopoly
profits are positive. in is also a dominant strategy for B because as before, A will drop out
in the next period.
In the t = 0

9 subgames, duopoly profits are positive for both, so both play in.

Thus, the SPE take the following form:

As strategy:
Monopoly node: Stay in 0-19. Any mixture at 20. Out after 20.
Duopoly node: Stay in 0-10. Exit 11 or later.
Bs strategy:
Monopoly or duopoly node: Stay in 0-24. Any mixture at 25. Out 26 or later.
41.

a) The planner solves

max [yp + y1 + y2 ]

ap ,a1 ,a2

which yields ap = a1 = a2 = 1. The resulting total family income is 11.5

b) Each player i has a dominant strategy of choosing ai = 3. This yields a unique NE of
(3,3,3). The resulting family income is 5.5.
a2

c) Notice that by naming action ai , i creates a (combined) negative externality of 3i on

the others. By taxing i the value of this externality (a Pigouvian tax), i internalizes his
a2
eect on the others. Thus, let is transfer be ti (ai , aj , ak ) = 3i . is problem is now
"
!
#
a2j
a2k
a2i
a2i
max
ki + ai
ai
6
6
6
3
which has solution ai = 1, coinciding with the social optimum.5
d) Lets start with the subgame where the parent faces incomes yp , y1 , y2 . The parent solves

1
1
max ln cp + ln c1 + ln c2
subject to cp + c1 + c2 = yp + y1 + y2 .
cp ,c1 ,c2
2
2
This is a standard Cobb-Douglas maximization problem (with prices all 1 and income
yp + y1 + y2 ). The parent will redistribute the income in shares 1 : 12 : 12 . Therefore, the
goal of all parties going into the subgame is to maximize total income in stage 1.
Therefore, in stage 1, i solves
max[yp + y1 + y2 ]
ai

which yields solution ai = 1 for all i, coinciding with the social optimum.
5

This tax does not balance the budget, but it is a simple matter to find one that does. One possibility is

ti (ai , aj , ak ) =

a2
i
3

2
a2
j +ak
.
6

31

The SPNE is thus

Children:
Parent:
42.

name ai = 1 for i = 1, 2
name ap = 1; facing Y = yp + y1 + y2 ! redistribute in shares 1 :

1
2

: 12 .

a) The normal form of the game is

A/B
C
D

C
x
x
2,1
2
1 x, x

D
x, 1

1 x 1+x
2 , 2

For B, neither strategy is strictly dominant. We can identify behavior using the following
table:
As dominant strategy
D
None
None
None
C

x
2 0, 13
= 13
1 2
3, 3
= 23
> 23

PSNE
(D, D)
(D, D)
None
(C, C)
(C, C)

If x 2 0, 13 , (D, D) is the unique rationalizable

profile, and therefore, the unique Nash

2
equilibrium. Similarly, if x 2 3 , 1 , (C, C) is the unique rationalizable profile, and
therefore the unique Nash equilibrium. If x = 13 , observe that if A plays C with positive
probability, any best-response by B involves playing C with positive probability. Note
that for every strategy of Bs that puts positive probability on C, A does strictly better
by playing D than by putting any weight on C. Therefore, the unique NE is (D, D).
Similarly, if x = 23 , the unique NE is (C, C).
Now consider x 2 13 , 23 : the unique N E is the MSNE ((1 x) C + xD, (3x 1) C + (2 3x) D).

b) Given a deployment x, any SPE involves the play of the corresponding NE above. Therefore, a choice of x results in expected payos for A as given below:
x

As expected payos
1
3
1 2
3, 3
2
3

Observe that M axx2( 1 , 2 ) 3x(12 x) =

3 3
in any SPE, A sets x = 0 or x = 1.
43.

1 x
2
3x(1 x)
2
x
2
3
8

<

1
2

= M axx2[0, 1 ] 1 2 x = M axx2[ 2 ,1] x2 . Therefore,

3

a) In Version #1, i receives payos

S (n) =

bn if i chooses Out

B (n) = c + dn if i chooses In
No player has dominant strategies; in particular, there is a PSNE where every player
chooses Out and receives payo S (0) and another PSNE where every player chooses In
and receives payo B (N 1). It can be shown that these are the only two equilibria.
Let there be another equilibria where there exists M 2 (0, N ) such that individuals
{1, ..., M } play In and individuals {M + 1, ..., N } play Out [given that payos are symmetric, any other equilibrium is equivalent to some such equilibrium]. For individual
32

M to be playing a best-response, it must be that B (M 1) > S (M 1). Since

B (M ) > B (M 1) > S (M 1) > S (M ), it must be a unique best-response for M + 1
to also play In leading to a contradiction.
Since both equilibria exist regardless of how S (0) relates to B (N 1), there is no
tendency for the equilibrium to necessarily be efficient.
b) In Version #2, i receives payos
S (i, n) = ai

bn if i chooses Out

B (i, n) = c + dn

ei if i chooses In

The game is indeed dominance solvable and involves every individual choosing In. Let
R (i, n) = B (i, n) S (i, n), and let the abbreviation ISD stand for Iterative elimination
of strictly dominated strategies.
Lemma 1: It is strictly dominated for 1 to choose Out.
Pf : Observe that the incremental utility of going In for player 1 when n others choose
In is
R (1, n) = c e a + (d + b) n
Observe that for all n > 0, R (1, n) > R (1, 0) = c e a > 0. Therefore, regardless of
the choice of others, it is a dominant strategy for 1 to choose In.
Lemma 2: If ISD prescribes that individuals {1, ..., M } must choose In, then ISD prescribes that M + 1 also chooses to go In.
Pf : Observe that R (M + 1, k) is strictly increasing in k; therefore, after ISD prescribes
that individuals {1, ..., M } choose In, then there are at least M players who choose In.
Therefore, for every n M ,
R (M + 1, n)

R (M + 1, M )
= R (M, M

1) + (d

R (M, M

1) > 0

e)

(a

b)

where the last inequality follows from the fact that ISD prescribed that individual M
choose In. Therefore, ISD prescribes that individual M + 1 chooses to go In.
Therefore, by Induction, in any rationalizable strategy profile, all individuals choose to
go In. Thus, this is what happens also in every CE and NE.
c) For the case of N = 3, observe that by b., on the path of play, all 3 individuals shall
choose to go In. We have to specify o-path behavior for a SPE, and this involves the
computation of multiple tedious cases.
44. Public Good Game
a) Normal Form
c
n
c 2a, 2a a, 1 + a
n 1 + a, a
1, 1
Contributing yields a < 1, so not contributing is a dominant strategy. Thus, the unique
NE is (n, n).
b) Notice that punishing is costly, so no player will choose to punish his opponent in the
subgame. The SPNE involves (n, n), followed by no punishment in the second period.
33

i. Now players care about equity. Inequity in monetary payos is not desirable, where
inequity in favor of your opponent is worse than inequity in your favor.
ii. Normal form:
c
n
c
2a, 2a
a 1 , 1 + a
2
n 1+a
2
1, 1
1, a
Notice that (n, n) is still a NE, as deviating to c reduces payo and decreases equity.
(c, n) and (n, c) can never be equilibria, as deviating from c to n increases payo and
decreases inequity. However, (c, c) can be sustained provided players have enough
distaste for inequity in their favor. This condition is given by 2a > 1 + a
i , or
i

>1

a for i = 1, 2.

iii. Imagine that players start the sub-game with wealth levels Y1 and Y2 .
Suppose Y1 > Y2 . There is no eqm in which only 1 punishes, as this reduces payo
for 1 and decreases equity. For 2, punishing 1 dollar reduces payo by 1, but via the
reduction in inequity, increases payo by 2 (K 1). This will be profitable provided
2 (K 1) > 1 or 2 > K1 1 . In this case, 2 will punish until the players have equal
monetary payo:
Y1 Y2
Y1 Kp = Y2 p ) p =
.
K 1
The resulting payos are 1 = 2 = KK 1 Y2 K1 1 Y1 .
If instead we have 2 < K1 1 , no player punishes. If 2 = K1 1 , 2 picks any p p .
The case Y1 < Y2 is symmetric to the case above.
If Y1 = Y2 , neither player punishes.
There are other equilibria. For example, if both players have i > K1 1 and Y1 > Y2 ,
then (p1 , p2 ) is a NE when
Y1 Y2
p2 = p1 +
.
K 1
Call i an enforcer if i has i > K1 1 .
If neither player is an enforcer, then there will be no punishment in the subgames,
and the equilibria are as in (d).
If both players are enforcers, then (n, n) can be sustained in equilibrium, but so too
can (c, c). Notice that i would never deviate to n, as that would reduce js stage
1 payo, and following punishment, players will have equal payos, which will be
lower than js payo from the first stage. (n, c) and (c, n) can never be sustained,
as deviating from c to n increases payo, and reduces punishment.
If only 1 is an enforcer, (n, n) can be sustained and (c, n) and (n, c) cannot, for
reasons identical to the two enforcers case. (c, c) can be sustained provided 1 has
strong distaste for inequity in his favor: 1 > 1 a, the condition from part (d).
If only 2 is an enforcer, the analysis is identical.
45.

a)

i. See attached figure.

ii. In period 1, each player chooses to clap (C) or not clap (N ). Should both players
have clapped in period 1, each player chooses C or N in 2. Thus, we have S1 =
S2 = {CC, CN, N C, N N }.

34

Normal form:
CC
CC
CN

d
2

CN

2c, d2
0, d

NN

0, d

2c, c d

2c

c, d

NC

2c d

NC

c, c

c
c

NN

c, 0 d
c, 0

c, 0
c, 0

0, d

0, 0

0, 0

0, d

0, 0

0, 0

Marked with a * above.

iii. We look at behavioral mixed strategies, keeping Kuhns theorem in mind.
There is a unique proper subgame which is reached when both players clap in period
1. Notice that in the final period, cost c is sunk for each player. Clapping costs
c and yields at worst d2 > c, so clapping is a dominant strategy. To find the first
period action, we have reduced normal form:
C
C

d
2

2c, d2
0, d

N
2c d

c, 0
0, 0

This reduced game has 3 equilibria. (C, N ) and (N, C) are pure equilibria.
c)
( C + (1
)N, C + (1
)N ) is the mixed strategy equilibrium, where = 2(d
2c+d .
Thus, we have three SPNE, corresponding by the actions given above, combined
with C, C in the subgame. Corresponding payos are (d c, 0), (0, d c) and (0, 0).
b)

i. Starting in the third period, observe that clapping is a dominant strategy. Moving
back to the second period, clapping is again a dominant strategy. This is the case
since d2 > 4c, clapping guarantees a positive payo, even if one is forced to split the
prize in the end. We now find actions in the first period by looking at the reduced
normal form:
C
N
C

d
2

3c, d2
0, d

3c d
c

c, 0
0, 0

This reduced game has 3 equilibria. (C, N ) and (N, C) are pure equilibria.
( C + (1
)N, C + (1
)N ) is the mixed strategy equilibrium, where = .
Thus, we have three SPNE, corresponding by the actions given above, combined
with C, C in periods 2 and 3. Corresponding payos are (d c, 0), (0, d c) and
(0, 0).
ii. Starting in period 3, we see that clapping is a dominant strategy. To find period
2 actions, we solve the same reduced normal form game as in (a) iv, which yielded
three possible outcomes.6 To find first period actions, we examine the reduced
normal form using each of these three second period outcomes:
6

Note that in this case, we have a sunk cost of c, so all payos are reduced by c. But this does not aect our
equilibria.

35

Second period actions (C, N ) ! outcome (d

c, 0) !

C
C

2c, c d

0, d

N
c, 0
0, 0

This game is dominance solvable with unique NE (C, N ). Thus, we have

SP N E 1 = (CCC, N N C)
Similarly, second period actions (N, C) ! outcome (0, d

(18)
c) !

SP N E 2 = (N N C, CCC)

(19)

The third outcome involved payos (0, 0), yielding reduced normal form:
C
N
c, c d c, 0
0, d c
0, 0

C
N

This reduced game has 3 equilibria. (C, N ) and (N, C) are pure equilibria.
(C + (1 )N, C + (1 )N ) is the mixed strategy equilibrium, where = 1 dc .
Thus, we have three SPNE, corresponding by the actions given above, combined
with the mixture in period 2, and (C, C) in period 3. Corresponding payos are
(d c, 0), (0, d c) and (0, 0). To sum up,

c)

i. Costs (T

SP N E 3 = ((C, C, C), (N, C, C))

(20)

SP N E 4 = ((N, C, C), (C, C, C))

(21)

SP N E 5 = ((C, C, C), (C, C, C))

(22)

1)c are sunk. Clapping yields an additional

c + (1

p)d + p p [ c + (1

p)d + p p [ c + (1

p)d + p [. . .

which is a geometric series, reducing to

1
1

p2

[ c + (1

p)d] .

ii. We look for a stationary equilibrium in which players clap with probability p in
every period. For A to be indierent between clapping and not clapping, we must
have
1
[ c + (1 p)d]
=
0
|{z}
1 p2
|
{z
}
payo from not clapping
payo from clapping

which yields

p =
Equilibrium payo is (0, 0).
36

iii. One asymmetric equilibrium is that 1 chooses to clap in every period and 2 chooses
not to clap in every period. This yields payos (d c, 0). There are other eqa, for
example, asymmetric equilibria with a tail in which players clap with probability p .
46.

a)

i. Candidate 1s strategy set is who he will attack: S1 = {2, 3}. Player 2 has two
information sets in which he can make a decision (1 attacked 2 unsuccessfully, 1
attacked 3 unsuccessfully). In the other situations, he is not in the game or can
only attack 1 (which we will take as a set move rather than a choice). Therefore,
his strategy set is S2 = {11, 13, 31, 33}. Finally, player 3 has four information sets
in which he can make a decision (1 attacked 2 unsuccessfully then 2 attacked 1 unsuccessfully, 1 attacked 2 unsuccessfully then 2 attacked 3 unsuccessfully, 1 attacked
3 unsuccessfully then 2 attacked 1 unsuccessfully, 1 attacked 3 unsuccessfully then
2 attacked 3 unsuccessfully). So, his strategy set contains 16 elements. Note that
even though player 3 has 4 information sets, the actions and payos are the same
for each.
ii. Two things to note about this game: (1) Whenever it is a candidates turn to attack,
if the number of surviving opponents is less than 2, he has no choice to make; (2)
For each i = 1, 2, 3, all subgames starting with candidate i attacking while both
opponents still surviving are the same in terms of payo, disregarding the history.
So this game essentially consists of three (classes of) subgames, namely, for each
i = 1, 2, 3, Gi denotes the (class of) subgame starting with candidate i deciding
between attacking one of his two opponents.
First consider subgame G3 . Candidate 3s survival probability is now 1. Given
this, he would like to attack the opponent with higher pi . Therefore, candidate 3s
strategy is to attack 1 if p1 > p2 , and to attack 2 if p1 < p2 .
Now consider subgame G2 . If p1 > p2 , candidate 2s survival probability is p2 (1
p3 ) + (1 p2 ) if he attacks 1 and p2 + (1 p2 ) if he attacks 3; if p1 < p2 , candidate 2s
survival probability is p2 (1 p3 )+(1 p2 )(1 p3 ) if he attacks 1 and p2 +(1 p2 )(1 p3 )
if he attacks 3. In both cases, attacking 3 yields strictly higher survival probability
than attacking 1 for candidate 2. Therefore, candidate 2s strategy is to attack 3.
Finally consider subgame G1 (the whole game). Note that whomever candidate 1
attacks, if his attack is not successful, we are in subgame G2 which has a unique
NE as shown above; therefore 1s surviving probability conditional on his attack not
successful is the same whether he attacks 2 or 3. Now if his attack is successful,
attacking 2 gives him surviving probability of 1 p3 (since now that 2 is out, 3
will for sure attack 1), and attacking 3 gives him surviving probability of 1 p2 .
Therefore, candidate 1s strategy is to attack 2 if p2 > p3 and to attack 3 if p2 < p3 .
To summarize, the unique SPNE is: Candidate 1 attacks 2 if p2 > p3 and attacks 3
if p2 < p3 ; If candidate 1s attack is not successful, candidate 2 attacks 3; If neither
1 nor 2s attack is successful, candidate 3 attacks 1 if p1 > p2 , and attacks 2 if
p1 < p2 ; In all other events, no choice needs to be made.
iii. If p3 < p2 , candidate 3 survives with probability p1 + (1 p1 )(1 p2 ); if p3 > p2 ,
candidate 3 survives with probability (1 p1 )(1 p2 ).

b) As in the previous part, we only need to consider subgames G1 , G2 and G3 .

First consider subgame G3 . Candidate 3s survival probability is now 1. Given this, he
would like to minimize the danger posed by the survival of other opponents and therefore
will not want to spend on the charity cause. So he will attack the opponent with higher
pi (just like in the previous part). Now given that p1 < p2 , he will attack 2.
37

Now consider subgame G2 . Since p1 < p2 , candidate 2s survival probability is p2 (1

p3 ) + (1 p2 )(1 p3 ) if he attacks 1, p2 + (1 p2 )(1 p3 ) if he attacks 3, and 1 p3 if
he spends on charity. Attacking 3 yields strictly higher survival probability. Therefore,
candidate 2s strategy is to attack 3.
Finally consider subgame G1 (the whole game). Given the outcomes of the subgames,
if candidate 1 spends on charity his survival probability is 1. If he attacks either of the
two opponents, his survival probability is strictly less than 1. Therefore candidate 1s
strategy is not to attack but instead to spend on the charity cause.
To summarize, the unique SPNE is:
Candidate 1 does not attack;
If candidate 1 does not attack or his attack is not successful, candidate 2 attacks 3;
If there has been no successful attack, candidate 3 attacks 2;
In all other events, no choice needs to be made.
It diers from the SPNE in part (1) only in that candidate 1 now does not attack. This
will ensure that 2 and 3 fight between themselves and therefore ensure himself a survival
probability of 1.
47. ?
48.

a) The extensive form is straightforward. Pure strategies: each player makes a decision at
only one information set, so the pure strategy set for each is {perform,wait}, except for
the leader at t = 4, who has no choices (and who therefore is not really a player we will
henceforth ignore him). There are eight strategy profiles of the form {s1 , s2 , s3 }, where
si is either perform or wait. All strategy profiles with s1 = perform lead to payos of
(4,8,8). All strategy profiles with s1 = wait and s2 = perform lead to payos of (6,2,6).
All strategy profiles with s1 = s2 = wait and s3 = perform lead to payos of (4,4,0).
Finally, the strategy profile (wait,wait,wait) leads to payos of (1,1,1).
i. Leader 3 will wait (0 1). Therefore, leader 2 will perform (2 1). Therefore,
leader 1 will wait (4 6). The task will be performed at t = 2.
ii. Payos are (6,2,6). Only performing at t = 1 makes leader 3 better o, but that
makes leader 1 worse o. Therefore the outcome is Pareto efficient.
iii. Yes, the outcome must be Pareto efficient. The proof is simple: There cant be an
earlier performance date that makes everyone better o; if there was, the leader at
that date would break the equilibrium by performing the task. Nor can there be a
later date that makes everyone better o, because vt ct is assumed to be strictly
decreasing in t.
b)

i. Leader 3 will wait (0 1). Leader 2 will wait (2 4). Leader 1 will wait (4 6). So
the task will be performed at t = 4.
ii. Payos are (1,1,1), compared with (6,2,6) in the subgame perfect Nash equilibrium,
so everyone is worse o when they behave naively. Clearly, the outcome is not
Pareto optimal.
iii. The task is performed later with naive players than in the subgame perfect Nash
equilibrium (t = 4 instead of t = 2). More generally, the task is performed weakly
later when agents are naive. Let Vte be the continuation utility that leader t expects
to receive in equilibrium if period t has arrived and he decides to wait. Let Vtn be
the continuation utility that a naive leader t expects to receive if period t has arrived
and he decides to wait. Obviously, Vtn Vte . Therefore, if wait is the equilibrium
38

strategy for leader t, it must also be the naive choice for leader t. Consequently,
the team cannot perform the task sooner if all leaders are naive.
49. Hide and Seek
50.

a) A strategy for Player 1 is a mapping from all the dierent time and position (t, k)
configurations at which he might be called to drive to the set {e, w}. In particular note
that Player 1 only drives on odd days, and if we denote the driving positions k on the
map as:
M = { (x

1), ...

1, 0, 1, ..., x

1}

then Player 1 can only ever be called to drive at cells with an even label (and is always
called to act at such cells). So if we let K1 = {(t, k) : t
1, t is odd, |k| x
1, k is even, k < t}, then a strategy for Player 1 is a function s1 : K1 ! {e, w}. Note
that the last inequality in the definition of K1 just addresses the fact that some cells
are too far away for the Player to be called on to drive at them in the early days of the
trip. The set of strategies for Player 1 is the set of all such mappings. Similarly if we let
K2 = {(t, k) : t 2, t is even, |k| x 1, k is odd, k < t}, then a strategy for Player 2
is a function s2 : K2 ! {e, w}.

b) Player 2 is never called on to act in this case, so the problem is just an optimization
problem in solitude for Player 1. Since v < v by assumption, the only Nash equilibrium
and the only subgame perfect Nash equilibrium of the game is given by the strategy
s1 (0) = w, leading to payos ( v, v).
c)

i. No. Under any strategy profile either x = 1 or x = 1 is reached. If the players

are to remain oscilating forever their payos are (0, 0) and it must be the case that
at whichever of these positions is reached, Player 2s strategy prescribes going back
to 0. He could deviate and prescribe going to the nearest endpoint an get strictly
positive profits.
ii. Consider the strategies given by:
s1 (t, 0) = e, 8t
s2 (t, 1) = s2 (t, 1) = e 8t

Player 2 is getting his prefered outcome so it is clear that he has no incentives to

deviate. By deviating Player 1 can only postpone the arrival of the party at the far
east, thereby hurting himself, so he has no incentives to deviate either.
iii. For a strategy profile s to be a Nash equilibrium in which the Far east is reached
(and Nash is a necessary condition for subgame perfect Nash) it must be the case
that s2 (2, 1) = e, since otherwise Player 1 could set s1 (1, 0) = w and they would
reach the Far West at t = 2 and for Player 1 this is strictly the best outcome. For
player 2 to set s2 (2, 1) = e in a subgame perfect equilibrium it must be the case
that the payo that he gets by doing so is at least 2 v, which is what he would get by
setting s2 (2, 1) = w. The most that he could hope to get by setting s2 (2, 1) = e
is 4 v (if they went all the way to the Far East after his move). So a necessary
2 v. So we have that if v < 2 v there
condition for an equilibrium of this kind is v
2 v consider the strategies that
is no such equilibrium. For the case in which v
we proposed in part d). It can be verified that they constitute a subgame perfect
Nash equilibrium.
39

iv. Let t be the largest even t such that v

by:

t 2v

and consider the strategies given

s1 (t, 1) = w 8t < t 1, s1 (t, 0) = e 8t t 1

s2 (t, 1) = e 8t, s2 (t, 1) = w 8t < t and s2 (t, 1) = e 8t

Note that in this proposed equilibrium the Far East is reached whent t = t , and

the payos are ( t v, t v). Player 1 has no profitable deviation, since by altering
his strategy either going west (w) at t t 1 he only weakly delays the arrival of
the party at the Far East, and by going east (e) at t < t 1 does not aect the
outcome given the self-flagelating strategy of player 2. Player 2 has no profitable
deviation either. It is clear that he cant possibly improve by switching s2 (t, 1)
from e to w for t
t 2, since this can only delay the arrival of the party to
the east. Moreover, given that position k = 1 is never reached when t < t on
the equilibrium path (given Player 1s strategy), switching s2 (t, 1) from w to e for
t < t , has no eect. Since on the equilibrium path, the last time that the party
visits 1 is at t 2, switching s2 (t, 1) from e to w has no eects for t > t 2.
Now lets check that Player 2 prefers to oscilate rather than to concede goinf to the
Far West, by setting s2 (t, 1) = e at some point t t 2. It is clear that if he
finds it profitable to do this, then the sooner the better. The soonest at which he
could break the oscilation is at t = 2 whne they frist arrive at k = 1. If Player 2
were to deviate at x = 1 when t = 2 by setting s2 (2, 1) = w he would get 2 v,

which is strictly less than his equilibrium payo t v given that v t 2 v.

So we have established that there is a Nash equilibrium in which the party reaches
the Far East at time T = t . No such equilibrium exists for T > t and we prove
it by contradiction. Suppose that there exists equilibrium s existed in which the
Far East (FE) was reached at even time T > t (T has to be even simply becuase
endpoints are always reached in even periods). In any Nash equilibrium it must
be true that if position k = 1 is reached at time t on the equilibrium path, then
s2 (t, 1) = e (i.e. Player 2 ceases the first actual opportunity to get to the Far East).
This implies that in s , the first time that k = 1 is reached is actually T . But
this implies that s1 (t, 0) = w 8t T 1. In particular s1 (1, 0) = w. This in
turn implies that s2 (2, 1) = e (otherwise the game would end in the Fasr East when
t = 2). However setting s2 (2, 1) = w would yield 2 v to Player 2 and this is greater
than T v, since T v < 2 v. This last inequality is true since by assumption t is the
t 2 v.
largest even t such that v
v. In any subgame perfect equilibrium it must be true that s2 (t, 1) = e 8t. So if the
Far East is reached with delay (T > 2), it must be that Player 1 is delaying the
arrival. In particular it must be true that s2 (1, 0) = w. Player 1 would be strictly
better o accelerating the process, by setting s1 (1, 0) = e and getting 2 v instead of
T v. So the answer is T = 2: If the Far East is the outcome in a subgame perfect
equilibrium, then it must be reached with no delay.
d)

i. Consider the strategies given by:

s1 (t, 0) = w, 8t
s2 (t, 1) = s2 (t, 1) = w 8t

Player 1 is getting his preferred outcome so it is clear that he has no incentives to

deviate. By deviating Player 2 can only postpone the arrival of the party at the Far
West, thereby hurting himself, so he has no incentives to deviate either.
40

ii. Consider the strategies given by:

s1 (t, 0) = w, 8t
s2 (t, 1) = e 8t and s2 (t, 1) = w 8t
In any subgame in which Player 1 is called to drive, he gets his prefered outcome,
so he never has an incentive to deviate. At subgames which start at position k = 1,
player 2 is acting optimally by setting s2 (t, 1) = e. So we just need to check subgames
in ehich player 2 is asked to drive at position k = 1. Given t1s strategy, by
deviating in such a subgame he can only delay the arrival to the Far West, so he is
strictly better o not deviating.
iii. There are no Nash equilibria in which the party arrives to the Far West at time
T > 2. The reason is that in a Nash equilibrium that ends at the Far West,
k = 1 cant be reached in the equilibrium path, since at that point Player 2 would
deviate by driving (e). This means s1 (t, 0) = w 8t. But this means that unless
s2 (2, 1) = w, player 2 is not best responding, since he would just be delaying the
partys arrival to the Far West.
iv. See 4d).
51. insert June 2010 Comp solution (Q2) ... tex file?
52.

a) Notation: a strategy for 1 in this game is given by (p1 , p2 ) where p1 , p2 and (1 p1 p2 )are
the probabilities 1 places on x, y, and z respectively. A strategy for 2 is given by q, the
probability 2 places on choosing l. Beliefs for 1 will always be ( 12 , 12 ). Beliefs for 2 are
(1 , 2 , 1 1 2 ).
Observe first that y is strictly dominated for 1, so in any NE, and hence in any PBE,
we have p2 = 0.
We look first for eqa where 1 places positive probability on z, so that 2s information set
is reached with positive probability. In this case, Bayes law implies 2s beliefs must be
1 = 2 = 12 . Now we can pin down 2s strategy: 2 (l) = 5 > 4.5 = 2 (r), so 2 must be
playing l. This pins downs 1s strategy: 1 (x) = 2 < 3 = 1 (z), so 1 must play z. Thus,
the unique PBE where 1 places positive probability on z is
1s strategy: z

2s strategy: l

2s beliefs: 1 = 2 =

1
2

(23)

Now look for eqa where 1 plays x only. For 1 to prefer x over z, we must have restrictions
on 2s strategy q:
1 (x)

1 (z) ) 2 12 q 0 +
) 2 13q 10
) q 12
13 .

1
2

q 6 + 12 (1

q)( 10) + 12 (1

q)( 10)

Now 2s strategy gives us restrictions on 2s beliefs.

If q 2 (0, 12
13 ], then 2 must be indierent between l and r. Thus, we have
2 (l) = 2 (r) ) 1 10 + 2 0 + (1
) 81 = 72 .
Thus, we have PBE:
41

2 )5 = 1 2 + 2 7 + (1

2 )5

1s strategy:
2s strategy:
2s beliefs:
If q = 0, then

x
q where q 2 (0, 12
13 ]
(1 , 2 ) where 81 = 72 and 1 + 2 1.
2 must (weakly) prefer r to l. Thus, we have

2 (l) 2 (r) ) 1 10 + 2 0 + (1
) 81 72 .
Thus, we have
1s strategy:
2s strategy:
2s beliefs:

2 )5 1 2 + 2 7 + (1

2 )5

PBE:
x
r
(1 , 2 ) where 81 72 and 1 + 2 1.

b) First note that any PBE in which all information sets are reached with positive probability is also a sequential equilibrium, so the eqm given in (23) is a SE.
Now consider the eqa where 1 plays x only. Observe that for any strictly mixed strategy
for 1, the beliefs generated for 2 must have 1 = 2 . It follows that the limit of beliefs
generated by any sequence of strictly mixed strategies must also have 1 = 2 . Therefore,
in any sequential equilibrium (SE) we must have 1 = 2 . Combining this with the
previous restrictions on 1 and 2 , the set of candidate SEs is reduced to
1s strategy: x
2s strategy: q where q 2 [0, 12
13 ]
2s beliefs:
1 = 2 = 0.
Can we in fact find strictly mixed strategies and corresponding beliefs that converge to
the equilibrium? Yes. We just need to pick the strategies carefully, making sure the
weight 1 places on z goes to zero faster than the weight on y.
(n)

(n)

Let 1 = (1 "n "2n , "n , "2n ). Let 2 = q + "n . Observe that as n ! 1, the
strategies converge to the equilibrium strategies. Also,
(n)

(n)

= 2

(n)

1 2n
2"
1 2n
+ 12 "2n
2"

1 n
2"
1 2n
2"

1 2n
2"

+ 12 "n
+

1 n
2"

"n
!0
2"n + 1

and

1
! 1.
+1

2"n

The beliefs converge to the eqm beliefs, so the candidates are indeed SE.
53.

a) See attached figure.

b) SA = {E, F }, SB = {GGG, GGH, GHG, GHH, HGG, HGH, HHG, HHH}
Normal form:
GGG GGH GHG GHH HGG HGH HHG HHH
E 0, 0 1.5, 1.5 0, 0 1.5, 1.5 3.5, 3.5 5, 5 3.5, 3.5
5, 5
F
3, 3
3, 3
7, 7
7, 7
3, 3
3, 3
7, 7
7, 7
c) The PSNE are marked in the normal form with a .

d) Subgame perfection requires that B play H when E. Thus, the pure strategy SPNE are
(E, HGH) and (F, HHH)

42

e) Observe that sequential rationality implies that B play H when E. Therefore in this
problem we have PBE PS-SPNE.
Let be the probability that B places on nature having played C when B faces F .
Observe that in the candidate PBE (F, HHH), Bs info set F is reached with positive
probability, and beliefs = .7 are determined from Bayes law. Thus, we have PBE
(F, HHH), = .7.
Consider (E, HGH). To sustain this as a PBE, Bs choice of G when facing F must be
sequentially rational. This places restrictions on . That is,
B (G)

B (H) ) 0 + 10(1

10 + 0(1

1
) ) .
2

Thus we have PBE (E, HGH), 12 .

f) The reasoning is identical to that in the last problem. Observe that for any strictly
mixed strategy for A, the beliefs generated for B must have = .7. It follows that the
limit of beliefs generated by any sequence of strictly mixed strategies must also have
= .7. Therefore, in any SE we must have = .7. Thus, the unique SE is (F, HHH),
= .7 (for which it is easy to show consistency).
54.

a) See attached.
b) Suppose P did not abandon the suit. Then D will oer q = max{0, v c}, and it will
be accepted by P. Thus P will withdraw the suit if v < c. Defendants and plaintis
expected payos are E[(c v)1v>c ] B and E[(v c)1v>c ] B respectively.
c) Since E[v] > c, P will not abandon the suit. Then D will oer E[v]
accept. Payos are c E[v] and E[v] c respectively.

c and P will

d) D
trial if E[(c v)1v>c ]R B = c(1 F (c))
R 1 would strictly prefer
R 1 to go to mock
Rc
c
vdF
(v)
B
>
c
vdF
(v)
or
vdF
(v) > B + cF (c). If 0 vdF (v) < B + cF (c),
c
0
0
then D will forego the mock trial. And if equality holds, D will go to mock trial with
some probability.
e) Sequential equilibrium puts restriction only on players beliefs at information sets reached
with 0 probability on the equilibrium path. We now construct a PBE thatR diers from
c
the sequential equilibrium constructed above. Let B + cF (c) 2c < 0 vdF (v) <
B + cF (c). Then as we know from above, in the sequential equilibrium, D would
choose to forego the mock trial, but here we can construct a PBE where D chooses to
go ahead with a mock trial: on the equilibrium path, where D chooses to do a mock
trial, everything is the same as in the SPE. At the other branch, let P believe that
v = 1 with probability 1 (this is an irrational belief, but not eliminated by Bayesian
updating). Therefore P will continue with the suit and reject any oer less than 1 c.
Then at Ds next info set, D believes that vF [0, 1], and oers to pay an amount less
than 1 c which is surely rejected. Note that given Ds belief at this information set,
oering 1 c has payo c 1, whereas oering anything less yields expected payo of
E[v] c. Then at her first info set, D chooses the mock trial. Given Ps crazy belief,
Ds expected payo from foregoing the mock trial is now E[v] c, and by our initial
assumption on the parameters, this is now less than B + E[(v C)1v C ].
55.

a)

i. The strategy set for the owner is gO : {0, V } ! R+ , and for the buyer is gB : R+ !
{accept, reject}.
43

ii. No. Suppose there is such a PBE, then there are two possibilities: Case (i) Separating equilibrium. Then, when the value is V , the company must be sold at price
p = V ; and when the value is 0, the company is not sold or is sold at price p = 0.
But then, when the value is indeed 0, the owner should set price p = V . Case (ii)
Pooling equilibrium. The pooling price must be p
V , for otherwise the owner
wont sell when the value is V . But meanwhile the pooling price must be p < V , for
otherwise the buyer wont buy.
iii. Yes. The seller quotes p = 0 for value 0, and p = V for value V . The buyer believes
that the value is 0 for any p < V , and V for p
V . This constitutes an PBE in
which the buyer does not buy for any price.
iv. Part (ii): In any separating equilibrium, price quoted for value 0 is 0, for value V
is V , and belief is 0 for p < V , V for p
V , then when the value is indeed 0,
the owner would want to set p = V . So there does not exist any separating PBE.
In any pooling equilibrium, let the pooling price be p, then must have p
V for
otherwise the owner wont sell when the value is V . For the buyer to buy, we must
1
have V
p. Together we have V
V , so we need
1 or
. In this
case, we have a PBE with any p 2 [V, V ], where the belief is that for all other p,
the value is 0. Part (iii): Yes. The seller quotes p = 0 for value 0, and p = V for
value V . The buyer believes that the value is 0 for any p < V , and V for p
V.
This constitutes an PBE in which the buyer does not buy for any price.
b)

i. The strategy set for the buyer is p 2 R+ , for the owner is gO : R+ {0, V } !
{accept, reject}.
ii. No. Suppose the buyer names price p. If p < V , only value 0 is sold. If p V , both
values are sold, but then the buyer wont name p.
iii. Yes. The buyer names p = 0. If the value is 0, the owner sells if and only if p > 0; if
the value is V , the owner sells if and only if p > V . This constitutes a PBE where
nothing is sold.
iv. The owners response function is unchanged. So the buyer will not name any price
p 2 (0, V ). If he names p V , both value 0 and value V will be sold, and the buyer
receives (expected) value of V
p, so the condition is the same as in previous
question:
When < 1 , there exists PBE where no sale is ever made, does not exist PBE
where a sale is made when the value is V ;
When
> 1 , there exists PBE where a sale is made when the value is V (in
particular, both values are sold at price p = V ), there does not exist PBE where no
sale is ever made;
When = 1 , both types of PBE exist.

c)

i. To avoid ambiguity, denote by q the probability that the owner has a liquidity problem. The strategy set for the buyer is p 2 R+ , for the owner is gO : R+ {0, V } !
{accept, reject}. (Since when the owner has the liquidity problem he has no choice
to make, this does not alter the owners strategy set.)
ii. The response function of a owner without liquidity problem is unchanged. The
buyer wont name p V as argued in the previous part. Now if he names p < V ,
he gets now qV , so his expected payo is nonnegative at any price p qV . So
a PBE involves that the buyer names p = 0. When the value is V , a sale is made
only when the owner has liquidity problem.
44

iii. There is no PBE in which no sale is made.

56. Note that in this problem, a strategy for player 1 is a price, and a strategy for player 2 is a
function describing what price to name for each possible choice of price for 1.
We solve using backward induction. Consider the subgame where 2 faces price p1 . 2s optimal
choice of p2 in this case is given by
If
If
If
If

p1
p1
p1
p1

any p2 greater than p1

any p2 greater than or equal to c
p2 = c + 1
p2 = p 1 1

<c
=c
=c+1
>c+1

The only non-obvious component of this strategy is that when p1 > c + 1, undercutting by
a penny is better than matching p1 . Lets verify that this is optimal. Suppose 1 names
p1 = c + k where k 2. p2 = c + k 1 is optimal when 2 (c + k) < 2 (c + k 1) or

Q(c + k)
Q(c + k)
k 1
k < Q(c + k 1) (k 1) ,
<2
.
2
Q(c + k 1)
k
In the final inequality we have LHS < 1 because Q() is decreasing, and the RHS
k 2, so p2 = c + k 1 is indeed optimal.

1 when

Note that there is a multiplicity of equilibria in this p1 subgame. However, the eqa are all
outcome equivalent (for 1 and 2), so that 1 can anticipate the outcome after each choice p1 .
Given the subgame outcomes, the only choice that yields positive payo for 1 is p1 = c + 1.
Thus, the set of SPNE is given by
1s strategy:
2s strategy:

p1 = c + 1
Any p2 (p1 ) that satisfies the conditions above.

The equilibrium outcome is that both players name price c + 1 and reap payo
57. We begin by analyzing the subgame where 1 locates at a and 2 locates at 1

Q(c+1)
2

1.

b.

If a = 1 b, the game reduces to Bertrand competition and we have eqm prices p1 = p2 = c.

Both firms receive 0 profit.
If a < 1 b, we need to find the prevailing equilibrium prices and the profits for each firm.
Profit for 1 is given by
1 (p1 , p2 , a, b) = (p1

1 , p2 , a, b)
c) (p

1 , p2 , a, b) is the consumer indierent between purchasing from 1 or 2. We have

where (p
v

p1

t(

a) = v

p2

t(1

1 , p2 , a, b) = 1
) ) (p

b + a p2 p1
+
.
2
2t

To find 1s best response to 2 naming p2 , 1 solves the maximization problem:

1 b + a p2 p1
max (p1 c)
+
,
p1
2
2t
which yields p1 (p2 ) = 12 p2 +

t(1 b+a)+c
.
2

Analogous reasoning for 2 gives p2 (p1 ) = 12 p1 +

simultaneously yields the equilibrium prices
t
p1 = c + (3 + a
3

b)
45

t(1 a+b)+c
.
2

Solving these two equations

t
p2 = c + (3 + b
3

a).

Profits are given by

1 (p1 , p2 , a, b) =

t
(3 + a
18

2 (p1 , p2 , a, b) =

b)2

t
(3 + b
18

a)2 .

Now, following location choices of a and 1 b, the firms can anticipate the profits above,
giving a reduced-form location game. But this location game has no NE! To see this, observe
that for any choice of 1 b, 1s payo is increasing in a on (0, 1 b). However, naming a = 1 b
yields 0 payo for both.
Equilibria with a < 1 b are ruled out because 1 could gain by moving to the right. But
equilibria with a = 1 b (0 profits) are also ruled out, because either firm could earn positive
profits by deviating to one side.
Thus, the game has no (pure strategy) SPNE.
58. The crux of this problem is recognizing the dierence between a) and b). The dierence lies
in the best-response condition for firms which do not enter in equilibrium. See below.
Q
First, some N -player Cournot eqm results: Inverse demand is given by p(Q) = ab
bI ; eqm
bc)I
quantity (per firm) is q c = (aN +1
; eqm price is pc = ab NN+1 (a bbc) ; eqm profit (per firm) is

c =

(a bc)2 I
;
b(N +1)2

best response function for i is qi (Q i ) =

(a bc)I Q
2

a) A Nash equilibrium will be a situation in which N firms enter and (i) each one produces
the Cournot quantity, (ii) each firm earns non-negative profits (iii) taking these quantities
as given, no additional firm would earn positive profits by entering. Therefore
(a bc)I
,
N +1
(a bc)2 I
i =
K 0,
b(N + 1)2
(a bc)2 I
j =
K 0,
4b(N + 1)2

(i)

qi =

(ii)
(iii)

where j represents the profits earned by a potential (N + 1)th entrant. For firms
choosing Not Enter in eqm, the optimal deviation is to enter and best respond to the
quantity choices of the others. That this deviation is not profitable is condition (iii).
Equilibrium price and consumer surplus are given by
p =
CS =

a
b
Z

N (a bc)
N +1
b
N qi

[p(q)

p] dq =

N
N +1

(a

bc)2
I.
2b

Therefore, from (iii), as I % 1 we must have N % 1 and

p & c, N qi % 1, and CS/I %

(a

bc)2
.
2

Curiously, qi % 1, since otherwise firms would have losses for large N (recall p & c and
K > 0).

46

b) In the second stage, given N, firms will produce the same quantity as above. Conditions
(i) and (ii) are identical. However, for firms that do not enter, deviating to Enter would
yield the (N + 1) firm Cournot outcome in stage 2. Therefore, condition (iii) becomes
(a bc)2 I
K 0.
b((N + 1) + 1)2
The same asymptotic results hold. Comparison of the conditions shows that for fixed I,
more firms will enter in (b).
(iii) j =

59. Assume (as in the lecture notes) that v is large, so that in eqm, firms always serve the entire
market, and monopoly profits are always positive. (Verify that large v achieves this!) Also
assume c = 0.
Lets begin with the second stage where given location choices, firms name price.
Case 1. 1 plant for firm 1. Here 1 is a monopolist and names v
serves the entire market.

t, the highest price that

Case 2. 1 plant for firm 1, 1 plant for firm 2 at opposite end. This is the standard Hotelling
model, yielding price p = t for each firm.
Case 3. 1 plant for firm 1, 1 plant for firm 2 at same end. Here we have Bertrand competition
and firms price at cost.
Case 4. 2 plants for firm 1 at opposite ends. Here each plant captures half the interval, and
the highest price that achieves this is p = v 4t at each plant.
Case 5. 2 plants for firm 1, 1 for firm 2. Here we have competition and p = c at one end
and p = 2t for firm 1s plant at the other end.
To summarize, we have (omitting symmetric cases):
1s location
10
10
10
11
11

2s location
00
01
10
00
10

prices
v t
t, t
0, 0
v 4t (in each plant)
p = 0 at one end, 2t at other

1
v t F
t
F
2
F
v 4t 2F
t
2F
8

2
0
t
2

F
F
0
F

Consider 2s entry/location decision, given 1s choice. Observe that 2 will enter only if 1 has
placed a single plant and 2t F . In this case 2 places the plant opposite 1s.
Consider 1s location choice. If 2t
F , 1 anticipates entry from 2 when he places only one
plant. He then compares 1 (10, 01) = 2t F to 1 (11, 00) = v 4t 2F , and therefore chooses
to place two plants. If 2t < F , he knows 2 will not enter, and compares 1 (10, 00) = v t F
to 1 (11, 00) = v 4t 2F . Thus, when F 34 t, 1 places two plants, and when F > 34 t, he
places one.
The SPNE7 is then:
Firm 1)

Firm 2)

if F 34 t, place two plants

if F > 34 t, place one plant
name Hotelling prices at pricing stage
if F 2t and 1 has placed only 1 plant, place plant at opposite end
else, dont place
name Hotelling prices at pricing stage

Trivially, there are multiple eqa in which we alter choices under indierence or alter where 1 places his single
plant.

47

The eqm outcome is that 1 places one or two plants (based on F ? 34 t), and 2 does not enter.
Notice that nothing changes if 1 is granted monopoly power. However, if 1 can only place
one plant, then 2 enters i F 2t (assuming entry when indierent). Observe that 2s
entry reduces transportation costs, but doubles the fixed cost. Social surplus is then given
t
by v 3t F whenever F > 2t and by v 12
2F otherwise. Therefore, for F 2 [ 12 t, 34 t), the
3
policy increases social welfare, for F > 4 t reduces SW, and for F < 12 t has no eect.
60. Throughout, if the consumer is indierent between buying and not buying, assume he buys.
This prevents firms from running into open-ness problems when naming prices.8
a) Lets begin with the stage 2 subgame. If Upstart has not entered, then CTWE has a
monopoly in both markets, and will extract all surplus, naming pS = RS and pJ = RJ .
If Upstart has entered, then in the Stu market, CTWE is still a monopolist and names
ps = Rs . In the junk market, we have Bertrand competition with diering costs. From
earlier analysis, we know that there is a continuum of equilibria; pJ = pJU = p is an
eqm for each p 2 [cJU , cJ ], where the consumer buys from the lower cost firm. However,
we are restricting attention to eqa where no firm prices below cost. Thus, we must have
pJU = pJ = cJ in the entry subgame. Profit in the entry subgame is given by
CT W E = RS

cS

U = cJ

cJU .

Returning to stage 1, we see that Upstart enters if cJ cJU > K (and is indierent
under equality). But this is exactly the parametric assumption we are given, so Upstart
enters.
The SPNE is then:
Upstart:
CTWE:

Enter; If Entry, set pJU = cJ

If No Entry, set pS = RS , pJ = RJ
If Entry, set pS = RS , pJ = cJ

b) Again we begin with the stage 2 subgame.

With no entry, CTWE will extract all surplus, naming pB = RS + RJ . With entry, we
have a variant of Bertrand competition, for which we must find the NE. We solve using
a series of claims about equilibria of the subgame with entry.
Claim 1: In any NE, the consumer makes a purchase.
If instead eqm prices are so high that the consumer purchase neither, either firm could
do better to name price just above cost.
Claim 2: In any NE, the consumer is indierent between the two firms.
Otherwise, the preferred firm could do better to raise price by ", keeping the customer
and raising profits. Thus, we have RS + RJ pB = RJ pJU , so pB = pJU + RS .
Claim 3: In any NE, some firm must be pricing at cost.
By assumption, neither firm is pricing below cost. If both were pricing above cost, in
view of claim 2, one of the firms (the firm losing out when the customer is indierent)
could do better to undercut the other by ", securing the customer for himself, while only
marginally reducing markup.
8
An alternative would be to treat the consumer as a player in the game, automatically pinning down his behavior
under indierence.

48

Which firm prices at cost depends on the parametric assumptions. CTWE pricing at
cost implies Upstart prices below cost, which is not allowed:
pB = cJ + cS ) pJU + RS = cJ + cS ) pJU = cJ + cS

RS < cJU

where the final inequality is the given parametric assumption. If Upstart prices at cost,
then CTWE prices above cost:
pJU = cJU ) pB

RS = cJU ) pB = cJU + RS > cJ + cS .

Here we resolve the consumers indierence in favor of CTWE (otherwise, at these prices
CTWE would undercut by "). Thus, NE prices are pJU = cJU , pB = cJU + RS . Profits
are given by
CT W E = cJU + RS cS cJ
U = 0.
We now return to the stage 1. Anticipating 0 profits in the entry subgame, Upstart will
not enter. Thus, we have SPNE:
Upstart:
CTWE:

Not Enter; If Entry, set pJU = cJU

If No Entry, set pB = RS + RJ
If Entry, set pB = cJU + RS .

c) Now CTWE just compares profits in (a) and (b). In (a), Upstart enters and CTWE
profits are RS cS . In (b), entry is deterred and profits are higher: RS + RJ cS cJ .
Thus, CTWE ties. The complete SPNE is for CTWE to tie, and then for parties to
behave in the tie/no tie subgames as described in (a) and (b).
Consumer welfare in this problem is zero, so to compare social welfare with and without
tying we find combined profits in (a) and (b).
(a) (RS cS ) + (RJ cJU
(b) (RS + RJ cS cJ )

K)

so SWa > SWb because cJU + K < cJ . Banning tying increases total welfare by shifting
production to the lower cost firm.
61. Assume that player 1 gets to make an oer first.
a) T odd (so that 1 makes period T oer).
1 (T ) = 1

2
P

t=0

2 (T ) =

1 2

... +
T

1
2

1
2

2
P

t t
1 2

1 (T )

t=0

t t
1 2

b) T even (so that 2 makes period T oer).

1 (T ) = 1

2
T

1 2

... +

2
P

t=0

t t
1 2

T
2

1
1

2
1 2

2 (1

1)
1 2

T
2

2
P

t=0

t t
1 2

1
1

2
1 2

2 (T ) =
1 1 (T )
! 12 (1 1 12 )
Identical analysis applies if 2 makes the first proposal.
49

62. We solve using backward induction.

a) If T is even: in period T , player 1 will accept any oer, so player 2 will oer a split of
(0, 1) and (continuation) payos will be (0, 1 c). Thus, in period T 1, 2 will accept
any oer above 1 c, so 1 oers a split of (c, 1 c) and (continuation) payos will again
be (0, 1 c). In period T 2, again 1 will accept any oer, because rejecting leads to a
subgame where he gets payo 0. Thus, 2 oers (0, 1).
This cycle continues back to time 1, so we have the following equilibrium:
1 oers (c, 1 c) in every period, 2 oers (0, 1) in every period. 1 accepts all oers and
2 accepts all oers 1 c.
The equilibrium outcome is that 1 oers (c, 1 c) in the first period and 2 accepts
immediately, yielding payos (0, 1 c).
If T is odd, the roles are reversed.
Here the strategies are exactly as above, and depend on the parity of T .
b) As one can tell, the equilibrium outcomes and strategies do not converge to a stationary
limit as T ! 1; in particular, all that the strategies and outcome depend upon is
T (mod2).
c) We restrict attention to stationary equilibria of the following form: at every oer node,
1 oers (x, 1 x), 2 oers (y, 1 y), 1 accepts any oer
y, and 2 accepts any oer
1 x.
We can do a bit more to relate x and y:
When 2 faces an oer (x, 1 x), rejection yields payo 1 y c. Thus, we must have
1 x 1 y c or x y + c. When 2 faces an oer (x + ", 1 x "), she rejects and
gets 1 y c. Thus, we must have 1 x " 1 y c 8" or x y + c " for every
" > 0. Thus, we must have x = y + c.
The proposed equilibrium is now that player 1 always oers (x, 1 x) at each oer node,
2 always oers (x c, 1 x + c), 1 accepts all oers
x c and 2 accepts all oers
1 x. Note that we require x 2 [c, 1].
We verify that this is in fact a SPE using the one-step-deviation principle.
When 1 faces oer (s, 1 s), rejection yields (continuation) payo x c. Thus, accepting
when s x c and rejecting when s < x c is optimal.
When 2 faces oer (1 s, s), rejection yields (continuation) payo 1 x + c c = 1 x.
Thus, accepting when s 1 x and rejecting when s < 1 x is optimal.
When 1 makes an oer (s, 1 s), any oer with s < x will be snapped up by 2 yielding
payo for 1 of s c < x c. Any s > x will be rejected, yielding payo x 2c < x c
for 1. Thus, (x, 1 x) is optimal.
When 2 makes an oer (s, 1 s), any oer with 1 s < 1 x + c will be snapped up by
1 yielding payo for 2 of 1 s c < 1 x + c c. Any oer with 1 s > 1 x + c will
be rejected, yielding payo 1 x c < 1 x for 2. Thus, (x c, 1 x + c) is optimal.
By the one-step-deviation principle, the profile is a SPE.
There are other non-stationary equilibria, including non-trivial equilibria where agreement is not reached in the first period. See Ariel Rubinstein, Perfect Equilibrium in a
Bargaining Model, Econometrica 97-109, 1982 for details.
63. Firm Spinos
50

a) In the N firm Cournot setting, we have

1
1
q =
p=
c =
N +1
N +1
c

1
N +1

Splitting will result in a 3 firm Cournot setting, so the board decides between taking 2/3
of total profits when N = 3 or 1/2 of total profits when N = 2. Since
2 2
1
1
2
>
4
3
the firm prefers to split.

b) In the second stage, per (spun-o) firm profits are

2
1
=
.
N1 + N2 + 1

Possible NE in the reduced game (ignoring additional symmetric cases) are then (1,1)
(1,2) (1,3) (2,2) (2,3) (3,3). We could solve using the normal form, or else by inspection.
We have eliminated (1,1) in part (b). (1,2) and (1,3) are eliminated, as in each case firm
1 prefers to split 2 ways rather than 1. (2,2) is ruled out as one firm would prefer to
split in 3. (2,3) is ruled out, as deviating from 2 to 3 is preferable. Finally, (3,3) is the
unique NE of the reduced game.
Thus, there is one SPNE: (3,3), followed by second period Cournot quantities.

64.

a)

i. In round 2, the proposer captures the entire surplus and oers 0. This oer is
accepted in equilibrium.
ii. If Vit is i0 s continuation value before the proposer is selected at t = 2, Vi2 = 13 .
iii. In round 1, if a proposer oers the other two agents their discounted continuation
value, they would accept this oer and reject anything less. Since 1 23 > 3 , the
proposer would be willing to oer each of the respondents their discounted cont.
value of 3 , and keep 1 23 .
iv. Vi1 = 13 (1 23 ) + 23 ( 3 ) = 13

b) By induction on a., it can be shown that Vit = 13 for every t. Therefore, the oer that
shall be made is 3 to each agent, and that will be accepted.
i. No, it does not.
ii. The proposer would oer 3 to one of the two other agents. She would keep 1 3
of the surplus.
iii. Vi1 = 13 1 3 + 23 12 3 = 13 .
iv. There are many possible asymmetric SPE. Here is one: at t = 1, Let 1 and 2 always
make their proposals to one another, and let 3 make his proposal to 1.
Then V11 = 13 1 3 + 23 3 = 13 + 9
V21 = 13 1 3 + 13 3 = 13
V31 = 13 1 3 = 13 9 .
65.

a) The equilibrium: In stage 5, B voids the transaction i quality is bad or p > v. In stage
3, S chooses e = 1 i p c. In stage 2, B accepts the contract with the lowest price in
the interval [c, v]; if there is no contract with a price in this interval, both are rejected.
In stage 1, S1 and S2 set p = c. The Bertrand result holds because, at any price above
costs, one seller can profitably steal business by undercutting the other.
51

b)

i. The normal form for the reduced subgame looks like this:
Monitor
Not Monitor
e = 1 p c, v p M p c, v p
e = 0 0, M
p, p
Case 1: p < M . In that case, not monitoring is a dominant strategy for B, which
means the game is dominance solvable, and the outcome is (0, Not Monitor). Payos
are (p, p).
Case 2: p = M . It is easy to check that (0, Not Monitor) is the only pure strategy
equilibrum, with payos (p, p).
Case 3: p > M . It is easy to check that there are no pure strategy equilibria. Let
denote the probability that S plays e = 1, and let denote the probability that
B monitors. Indierence for S requires
p
or

c = (1

)p

c
= .
p

Indierence for B requires

(v

p)

M = v

or
=1

M
p

S s expected payo in this equilibrium is plainlyp

with certainty from e = 1). Bs expected payo is 1

c (since
this is what he gets

M
vM
p (v p) M = v p
p

ii. In stage 2, B accepts the contract with the price yielding the greatest value of
v p vM
p provided this value is non-negative, and rejects both oers if these values
are both negative. In stage 1, S1 and S2 choose p to maximize v p vM
p . The
first order condition is:
vM
=1
p2
or
1
p = (vM ) 2
The second derivative is
2

vM
< 0,
p3

so the function is strictly concave, and the first order condition guarantees a maximum. At the maximum, Bs payo is
v

2 (vM ) 2 > 0,

as required, where the inequality follows from the fact that M <
1
2

v
4.

Here, the

Bertrand result does not hold, because p = (vM ) > M > c. A seller cant
1
profitably steal business by reducing price to a level between c and (vM ) 2 because
the continuation equilibrium is less attractive to the buyer in light of the eect on
eort and monitoring.
52

c) In part A, the seller would set p = v. In part B, the seller would select the largest price
consistent with non-negative payos for B: v p vM
0, which we can rewrite as
p
2
p
pv M v
0. Notice that this is definitely negative for p = v, so the monopoly
price is below v. Since Bs payos are strictly concave, the monopoly price is the larger
of the two roots of p2 pv + M v = 0.
66.

a)

i. The condition for improving on autarky is u0 (W ) < u0 (0). The social optimum
involves a gift g satisfying u0 (W g ) = u0 (g ).
ii. Lets define strategies recursively. Generation 1 gives g to generation 0 in period 1.
Every subsequent generation t gives g to generation t 1 in period t if generation
t 1 has chosen the action prescribed by its strategy, and 0 otherwise. If every
generation follows these strategies, each will give g , which conforms with the desired
social convention.
Lets check that this is a subgame perfect Nash equilibrium. Given any history, if
generation t follows its prescribed strategy, assuming t + 1 does so as well, t will
receive a payo of u(W g ) + u(g ). If generation t instead chooses some other
gift g, it will receive u(W g) + u(0). Since u(W g) + u(0) u(W ) + u(0)
u(W g ) + u(g ), the deviation isnt beneficial. Accordingly, we have a subgame
perfect Nash equilibrium. This answer does not depend on the value of (though,
for small and u0 (0) finite, the optimal convention may involve no gift).
iii. All of them are sustainable, and the answer doesnt depend on (except that
aects which conventions make every generation better o). Choose any g such
that u(W ) + u(0) < u(W gb) + u(b
g ). Then the argument in A(ii) goes through

with gb replacing g .
iv. None of them are sustainable, and the answer doesnt depend on (except that
aects which conventions make every generation worse o). Suppose on the
contrary that we have an equilibrium supporting a convention with a gift g 0 such
that u(W g 0 )+ u(g 0 ) < u(W )+ u(0). Let generation t deviate by giving nothing.
Then t consumes W in the first period of life, and not less than 0 in the second period
of life. Its payo is therefore bounded below by u(W ) + u(0), so its better o
a contradiction.
v. With a finite horizon, there are no gifts. This follows from backward recursion: the
last generation gives nothing to its predecessor because there are no consequences,
so the second-to-last generation gives nothing to its predecessor, and so forth.

b) No social conventions are sustainable (aside from giving nothing). Suppose on the
contrary that theres an equilibrium supporting a convention with a gift of b0 . Assume that generation t has received b0 in the first period of life, and that there have
been no deviations from equilibrium strategies. If t follows the convention, its payo is
v(b0 ) + v(F b0 ). If t gives nothing, its payo is v(b0 ) + v(F ). The deviation plainly
raises ts payo a contradiction.
i. With > 1, we know from part A that we can sustain a convention with any
g 2 [0, W ], and b = 0. The question is whether we can sustain other conventions.
Lets define strategies recursively. In the first half of period t, generation t 1 gives
b0 to generation t if he followed his strategy in the second half of period t 1 (which
is satisfied trivially in period 1), and zero otherwise. In the second half of period t,
generation t gives g 0 to generation t 1 if t 1 followed his strategy in both the first
53

half of period t, and in the second half of period t 1 (which is satisfied trivially in
period 1); otherwise, he gives nothing. If every generation follows these strategies,
then, within each period, the old generation gives its child b0 , and then the young
generation gives its child g 0 .
Lets check that this is a subgame perfect Nash equilibrium. Notice that generation
t makes two decisions in a row: one in the second half of period t 1, and the next
in the first half of period t. Suppose it has received a gift of b (possibly not the
equilibirum level) from generation t 1 in period t. If it follows its equilibrium
strategy, its payo will be (W g 0 )+b+ g 0 + (F b0 ) = (W + F +b)+( 1)g 0
b0 .
If it deviates to some other gifts g 00 and b00 , its payo will be (W + F + b) g 00
b00 .
00
00
Clearly, its most profitable deviation involves g = b = 0, which yields a payo
of W + F + b. Accordingly, we have an equilibrium provided that .(W + F +
b) + (
1)g 0
b0
W + F + b, or equivalently (
1)g 0
b0 . To put it
0
0
dierently, we can support all conventions defined by (g , b ) above the straight line
defined by g = 1 . An increase in reduces the set of sustainable conventions,
and an increase in expands it.
In contrast to part B, we can sustain conventions involving transfers of food. In
B, theres no way to discipline the elderly, so we cant force them to transfer food.
Here, we can discipline them by withholding water.
ii. We maximize welfare by making the gifts as large as possible. Clearly, we can set
0
g 0 = W . This is good in its own n
right, and
o relaxes the constraint on b as much as
1
0
possible. We then set b = min F,
. For the optimal convention, the level
of water transferred does not depend on or . The level of food transferred rises
with and falls with .
67.

a) In the case of indierence, we shall assume that the consumer buys the car from Company
A. At an equilibrium, it must be that vA pA = vB pB ; if vA pA > vB pB , then firm
A can increase its price without losing the consumer. Similarly, if vB pB > vA pA ,
firm B can increase its price without losing the consumer. If equality holds, then
pA = vA vB + pB . It also must be that pB = c; if pB > c, then Firm B could lower
its price infinitesimally, draw away the consumer and make a strictly positive profit.
Therefore, the equilibrium outcome is pB = c, pA = c + vA vB , and the consumer buys
the product from Firm A.
b) Answers below:
i. Given a value of d, Firm As profits are f (d) d.
ii. Firm A will choose d such that f 0 (d ) = 1. In the case where f (d) = d1/2 , d = 14 .
c) Answers below:
i. Firm is profits = di + max {f (di ) f (dj ) , 0}
ii. There does not exist any such equilibrium. If firms choose the same level of advertising, then in the Nash equilibrium of the 2nd stage game, both firms shall price
at marginal cost. Since each firm makes a loss of their advertising budget, Firm i
would be better o switching to di = 0.
iii. Consider the strategy profile where di = 0, and dj = d from (b) (ii), and in the
sub-game, pi (di , dj ) = c + max {f (di ) f (dj ) , 0}. This gives 0 utility to Firm i
and f (d ) d to Firm j. Observe that conditional on dj = d , Firm i receives a
strictly negative payo from deviating and setting di 2 (0, d ]. Let us now consider
deviations where Firm i sets di > d . Observe that her payo from doing so
54

is f (di ) di f (d ). Since d is the unique maximizer of f (d) d, note that

f (di ) di < f (d ) d , and therefore, f (di ) di f (d ) < d < 0, since by
assumption, d > 0. Therefore, this deviation also yields a strictly negative payo.
Thus, this is an SPE.
68.

a)

i. If p < v + s, buying is a dominant strategy, so all consumers will buy. If p > v + sI,
not buing is a dominant strategy, so no consumer will buy.
ii. For any p 2 [v + s, v + sI], there is a continuation equilibrium in which everyone
buys (since the benefit of buying is then v + sI p 0), and one in which no one
buys (since the benefit of buying is then v + s 0).
iii. For any p 2 [v + s, v + sI], one can construct a subgame perfect Nash equilibrium
in which the monopolist chooses p simply use the everyone buys continuation
equilibrium for p p , and the no one buys continuation equilibrium for p > p .
Since we have p v + s > c, this price is optimal for the monopolist.

b)

i. A strategy is a mapping from {w1 , ..., wM } into {BUY, NOT BUY}. An example:
choose NOT BUY regardless of the consumers realized value.
ii. Given the strategies of other consumers, let NE be the expected number of them
who will buy. If the consumer buys with value wk , then wk + s(NE + 1) p 0.
But wr + s(NE + 1) p > wk + s(NE + 1) p 0, which means she definitely buys
with value wr for r > k.
iii. Suppose consumers buy i vi
wk . When a given consumer decides to buy, she
expects the total number of buyers to be k + 1. If vi wk , she therefore expects
buying to generate a payo of vi + s(k + 1) p wk + s(k + 1) p = Wk (p) 0.
If vi < wk , she expects buying to generate a payo of vi + s(k + 1) p wk 1 +
s(k + 1) p < wk 1 + s(k 1 + 1) p = Wk 1 (p) 0. So all actions are optimal.
iv. If Wk (p)
0, then one of two things must be true: either (a) Wr (p)
0 and
Wr 1 (p) 0 for some r 2 {2, ..., k}, or (b) W1 (p) > 0. In case (a), the conclusion
follows from part iii. In case (b), there is an equilibrium in which consumers buy
irrespective of type.
v. If WM (p) 0, exsitence follows from step iv. If WM (p) < 0, there is an equilibrium
in which no consumer ever buys, irrespective of type.
vi. Suppose that, with p, there is an equilibrium in which consumers buy i vi
wk .
0
Then we must have Wk (p) 0. But then Wk (p ) > Wk (p) 0. By step iv, there
exists an equilibrium with p0 where consumers buy i vi wr for some r k.
vii. For c and c0 with c > c0 , let p and p0 be the monopolists optimal prices. We know
that (p c)x(p)
(p0 c)x(p0 ), and (p0 c0 )x(p0 )
(p c0 )x(p). Adding these
two inequalities, cancelling terms, and rearranging yields (c c0 )(x(p0 ) x(p)) 0.
With c > c0 , we must therefore have x(p0 ) x(p) 0. With x non-increasing, this
requires p p0 , as required.

69. Hotelling Spatial location

70. If s is a Nash equilibrium of the stage game, then the strategies each player i plays si in
each period form a SPNE of the repeated game.
To see that the above observation is correct, note that with these strategies, the future play of
is opponents is independent of how he plays today, so his optimal action today is to maximize
current period payo, i.e. to play a static best response to s i .
55

71.

a) The stage game is dominance solvable with PSNE (C, c). Because the stage game has a
unique NE, the only equilibrium of the repeated game is to play the static equilibrium
(C, c) in every period. [to clarify the argument, since the stage-game is dominancesolvable, (C, c) would be played at the final stage regardless of prior history. That
would imply that play at the final period is independent of play at the penultimate
period; then, the agents optimal action at the penultimate period is to maximize current
period payo and play (C, c); then by induction, this implies that the unique NE is to
play (C, c) in every period].
b) To sustain the cooperative choice (B, b), it must be that no player wishes to deviate by
choosing c (the optimal deviation):
1
9
1
| {z }
eqm payo

11 +
5.
1
|
{z
}
opt. dev. payo

1
So we require
3.
This is a SPNE by construction. We can verify using the one-step deviation principle.
We see that no player wishes to deviate if everyone has cooperated (shown above) and
certainly no player wishes to deviate in a subgame where Nash reversion is prescribed.
Thus, we have a SPNE.

72. Consider the following strategies where the if refers to play in the previous round:
Period 1
Period t > 1

Play (N F, N F )
if (N F, N F )
if (N F, F )
if (F, N F )
if (F, F )

(N F, N F )
(F, F )
(F, F )
(N F, N F )

To check that this is an equilibrium, we must ensure that no player wishes to deviate when
(F, F ) is prescribed or when (N F, N F ) is prescribed.
When (N F, N F ) is prescribed, 1s IC is:
3
or

(4 + ) (1
1
2

)+3

4 (1

2s IC is
3
which is satisfied when

)+3

1
2.

When (F, F ) is prescribed, 1 has no incentive to deviate. 2s IC is

3

(1
1
3

1
So for
2 , (N F, N F ) can be sustained.
also available].

73. ?
56

)+3

[there are other Carrot-and-stick punishments

74. To sustain the monopoly outcome, we require

m
1

d +

where m represents (per firm) monopoly profits in the N -player Cournot game, c represents
Cournot profits, and d represents is profits from best responding to the N 1 opponents
all naming q m , the collusive monopoly quantity.
Solving the N -player model yields m =
profits, and

c)2

(a
.
(N +1)2 b

To find

d,

we

(a c)2
4bN , which is
find i0 s optimal

max [(p(qi + (N
qi

which yields qi =
becomes

N +1 a c
N
4b

1
1

which reduces to

N +1
N

(a

1
N

times single firm monopoly

deviation:
c)qi ]

N +1 2 (a c)2
N
16b .

and profit d =

(a c)2
4bN

1)q m )

just

Thus, our no deviate condition

c)2
+
16b
1

(a c)2
(N + 1)2 b

(N + 1)2
.
(N + 1)2 + 4N

Observe that as N ! 1, ! 1. Hence with more firms, it becomes harder to sustain

collusion. This matches common intuition, although that intuition is largely built on detection
and enforcement problems which are not present in this model. In this model as N ! 1, we
2
have m ! 0 and c ! 0, while interestingly, d ! (a16bc) . Hence, for large N the payo to
deviating d dominates the system and unless is very close to 1, prevents collusion.
Question: Does this reasoning hold for Cournot settings with general demand function p(Q)?
75.

a) Observe that profits are decreasing in q on [q m , q c ], so that our problem becomes

min q

q2[q m ,q c ]

subject to

q sustainable via Nash reversion.

The condition that q is sustainable in equilibrium via Nash reversion is

(q)
1

d (q) +

(24)

where (q) are (per firm) single stage profits from naming q, d (q) are 1s profits from
best responding to 2 naming q, and c are Cournot profits. Routine analysis yields
(q) = (a

2bq

c)q

d (q) =

(a

c qb)2
4b

c =

(a

c)2
.
9b

Substituting into (24) yields

(a

2bq
1

c)q

(a

c qb)2
+
4b
1

(a

c)2
.
9b

To simplify the algebra, we use a 1-1 change of variables q = abrc .

Substituting into (25) yields

1
r 2
r 1 21
1
+
,
2
1
r
r
4 1
9
57

(25)

(9

5 )r2

(54

18 )r + (81

The problem is now

max r

r2[3,4]

9 ) 0.

(26)

subject to (??).

Note that the condition r 2 [3, 4] corresponds to the condition q 2 [q m , q c ].

Since (9 5 ) > 1, the LHS of (??) is a convex quadratic, so all values of r between the
two roots will satisfy the inequality. The roots are {3, 3 99 5 }, where since 2 (0, 1), the
second root is the greater of the two. Thus, our solution is

9
r = min 3
,4 .
9 5
9
9
9
Notice that 3 99 5 = 4 ) = 17
, so that for
< 17
, r = 3 99 5 .
17 , r = 4 and for
Finally, substituting r back into q, and then into (q), maximum sustainable profit is

(a
(a

c)2
8b

9
,
17

when

c)2 (9 5 )(9
9b(9
)2

7 )

when

<

9
.
17

b) Assume consumers split business equally when firms name the same price.
Suppose we wish to sustain some price p 2 (c, pm ]. Let corresponding (per firm) profits
be given by (p) > 0. The condition that p is sustainable in equilibrium via Nash
reversion is
(p)
2(p)
1
1
m
which reduces to
2 . The condition is independent of p, so that either all p 2 (c, p ]
can be sustained, or no p 2 (c, pm ] can.
Thus, maximum sustainable profits are

76.

when

when

1
,
2
1
< .
2

a) Both firms naming c1 and when indierent assuming consumer buys from firm 1, is a
NE for the stage game. Infinite repetition of this stage NE is a SPNE for the repeated
game, in which both firms earn zero profits. No equilibrium can yield lower payo to
either firm, as 0 is the minmax payo to each firm.
Below assume consumer resolves indierence by equally randomize at any p 2 (c2 , v],
and buys soly from firm 1 for all other price. No price above v can be sustained as the
consumer will not buy. To sustain p = v, consider reversion to the static NE as above.
For firm 1, requires 1 1 12 (v c1 ) v c1 , and for firm 2 requires 1 1 12 (v c2 ) v c2 .
1
Both yields
2 , same condition as in the standard Bertrand case. Therefore the set
1
of sustainable prices is [c1 , v] if
2 ; [c1 , c2 ] otherwise.
1
b) For
2 , the set of sustainable prices is [c1 , v] since we can already sustain all prices
without conglomerate markets. For < 12 , to sustain a price p, require 1 1 (p c1 )

(p

c1 ) + (p

c2 ). Solving yields p c2 +
58

(c2 c1 )
1 2

p . Note that firms will not charge

more than v, as this would lead to 0 profits. Therefore, the set of sustainable prices
for < 12 is [c1 , min{p , v}]. Since p > c2 as long as > 0, it is possible to sustain

some price above c2 for all > 0. dp

d > 0, so the highest sustainable price is strictly
increasing in until = 2v v c1c2 c2 12 (when p = v) and then constant at v for > 12 .
77. A strategy for player P is a first period choice m1 2 {1, 2}, and a second period choice
m2 (m1 , x1 ) 2 {1, 2} for each possible first period history (m1 , x1 ) 2 {1, 2} [0, 1]. Thus,
her strategy set is given by: SP = {1, 2} {m2 such that m2 : {1, 2} [0, 1] ! {1, 2}}. A
strategy for manager i 2 {1, 2} is a first period choice x1 2 [0, 1] (if elected in the first
period), and a second period choice x2 (m1 , x1 ) 2 [0, 1] (if elected in the second period)
for each possible first period history (m1 , x1 ) . Thus, her strategy set is given by: Si =
[0, 1] {x2 such that x2 : {1, 2} [0, 1] ! [0, 1]} .
a)

i. Notice that in any (subgame perfect Nash) equilibrium x2 = 1. Thus, P s payo will
be given by (1 x1 ) , and each manager will receive either zero or one in the second
period. Moreover, the equilibrium x1 must satisfy:
x1 +

1,

where the left hand side is the most m1 can obtain when selecting x1 , and the right
hand side is the least m1 can obtain by deviating in the first period. Therefore, P s
payo is bounded above by .
On the other hand, the strategy profile: m1 = 1, m2 (m1 , x1 ) = m1 i x1 1
;
x1 = 1
(for both managers), and x2 = 1 (for both managers) constitutes an
equilibrium that gives payo to P. Therefore, from the previous paragraph, is
the highest possible payo that P can obtain in equilibrium.
ii. Notice that the strategy profile: m1 = 1, m2 () 1; and x1 = x2 = 1 (for both
managers) constitutes an equilibrium that gives a payo of zero to P. Since P s
payo is bounded below by zero, zero is the lowest possible equilibrium payo for
P.
iii. The set of equilibrium payos for P is convex. To see this notice that any payo 2
[0, ] (i.e., between the highest and lowest possible equilibrium payos) is sustained
by the following equilibrium profile: m1 = 1, m2 (m1 , x1 ) = m1 i x1 1 ;
x1 = 1 (for both managers), and x2 = 1 (for both managers).
b) There does exist an equilibrium such that, on the path-of play, xt < 1 for all t. Fix
2 (0, 1), and consider the following profile:
m1 = 1,
8
mt 1
if xt 1 1 and mt 1 2 {1, 2}
<
{1, 2} mt 1 if xt 1 > 1 and mt 1 2 {1, 2}
mt =
:
1
if mt 1 2
/ {1, 2},

1 for i 2 {1, 2}
xt =
1
for i 2
/ {1, 2}.
Notice that the above profile constitutes an equilibrium for all . Finally, provided
N 2 (and ) the above profile constitutes an equilibrium with the desired property.
78. ?
59

79.

a) To sustain any positive profit (i.e. any price above c), the incentive constraints (i.e.
no profitable deviation) are
1

(1 + + ... +

ki 1

) + 0, 8i = 1, 2

1
Which (for all values of ) give ki
2 for i = 1, 2.
Therefore, the highest symmetric price sustainable is pm if
otherwise.

ki

1
2

for both i = 1, 2; c

1
k +1 < 1 . So the conditions
b) Let k be the nonnegative integer such that k
2 and
2
m

in the above question to sustain p are ki k for i = 1, 2.

In any SPNE, if ki > k for some i, the best response for i is to choose ; if any firm
chooses , the best response for the other firm is to choose . Therefore we have a SPNE
where both firms choose at the beginning, and both price at c in all periods regardless
of history.
Any other SPNE must involve ki k for both i = 1, 2. And since c0 < 0, this implies
m
that any other SPNE must involve k1 = k2 = k . Such a SPNE exists if c(k ) 1 1 2 .
To summarize:
We have a SPNE where both firms choose at the beginning, and both price at c in all
periods regardless of history;
m
If c(k ) 1 1 2 , we have a second SPNE where both firms choose k at the beginning,
both price at pm if no deviation is detected, both price at c if a deviation is detected.

80.

a) Suppose firm 1 plays a with probability and firm 2 plays a with probability . Minmax
payo for firm 1 is
min0

1 max01

( + (1
2

)(1

)) + ((1

) + (1

3
)) =
4

Similarly, minmax payo for firm 2 is

min01 max0

( + (1
2

)) =

)(1

b) We know each must at least obtain their minmax payo in any NE of the repeated game.
But note that the stage game is a constant-sum game, so if any firm obtains a payo
strictly higher than his minmax payo, it must be the case that the other firm obtains
a payo strictly below his minmax payo. Therefore, the highest payo each firm can
obtain in any NE is his minmax payo.
81.

a) The unique PSNE is (C,c)

b) Consider player 1. If the proposed equilibrium strategies are (A,a), cooperation will
give a payo of 8 for the rest of time, while deviating will give him a payo of 9 today,
but 2 after that (for the rest of time). Therefore, we need:
1
1

9+

9+

(2) )

1
7

(4) )

1
5

Similarly, for player 2, we need:

1
1

(Therefore, if both have the same discount factor, we require

60

1
5)

c) Remember that the most we can punish a player that deviates is to by giving them their
minmax payo for the rest of time. This punishment provides a lower bound on the
possible discount factors needed to achieve (A,a) in any Nash Equilibrium. Player 1s
minmax payo is 2 and player 2s minmax payo is 4 (the same as the payos from
(C,c)). Therefore, we cannot sustain any NE (or SPNE, which is a subset of NE) at a
lower discount rate than the one we found in (b).
82.

a) Note that the profits to one firm if both play a4bc are (a 8bc) . The profits to one firm if
both firms play a2bc are 0. The profits from the optimal deviation if the opponent plays
the

a c
4b

9 (a c)2
.
64
b
1 (a c)2
.
16
b

are

The profits from the optimal deviation if the opponent plays the

are
We have 1 constraint for the cooperation regime:
a c
2b

(a

9 (a c)2
+ ( + ... +
64
b

c)2
8b

)(0) +

(a

k+1

c)2
8b

Then, we have k constraints given that we are in the ith period of the punishment regime
(note that deviation leads back to being punished for k periods):
(1 + + ... +

k i

)(0) +

k+1 i

(a

c)2
8b

1 (a c)2
+ ( + ... +
16
b

)(0) +

k+1

(a

c)2
8b

b) Note that if the constraint for the first period of the punishment (i = 1) holds, the
constraints for the rest of the periods of punishment will hold as well. Therefore, we
just need to satisfy 2 constraints. Doing the math leads to two equations:
1
1
(1 + + ... +

k 1

(a

9 (a c)2
+ ( + ... +
64
b

c)2
8b

)(0) +

(a

c)2
8b

)(0) +

k+1

1 (a c)2
+ ( + ... +
16
b

(a

c)2
8b

)(0) +

k+1

(a

c)2
8b

Note that as k rises, the first equation becomes easier to satisfy (because the punishment
is harsher) while the second becomes harder to satisfy (because players want to deviate
from this harsher punishment more). However, for any k, if satisfies the first equation,
it will satisfy the second equation. Focusing on the second equation, we see that k = 1
1
leads to the lowest (
2 ) so a quicker punishment is best for the players.
83.

a)

i. Let T be the total net contributions of all other players. For a liberal, payos
depend on choice as follows: (T + b c)2 b2 . Maximizing over b, we obtain the
first order condition 2(T + b c) 2b = 0. Consequently, b = max {(c T ) /2, 0}.
Similarly, for a conservativecandidate, the payo is (T g + c)2 g 2 . Maximizing
over g, we obtain the first order condition 2(T g + c) 2g = 0. Consequently,
g = max {(c + T ) /2, 0}.
ii. Notice that we can rewrite the first order condition for liberal i as bi = c A,
where A represents aggregate (net) contributions, including is. Accordingly, bi =
max {c A, 0}, which is the same for all i. A similar argument applies for conservatives.

61

iii. Suppose that, in equilibrium each liberal gives b and each conservative gives g .
Then, for liberals, T = (N 1)b + M g . For b to be a best response, we must
have
c (N 1)b + M g
b =
2
which we can rewrite as
c (N + 1)b + M g = 0
(27)
For conservatives, T = N b + (M 1)g . For g to be a best response, we must
have
c + N b (M 1)g
g =
2
which we can rewrite as
c + N b (M + 1)g = 0
(28)
Solving (28) and (27) yields
b =

(2M + 1)c
M +N +1

and

(2N + 1)c
0
M +N +1
(so the non-negativity constraints are satisfied). This leads to the policy

N M

x =
c
M +N +1
g =

iv. With

N
M

= k, we have
b =

1
2+ M
1
1+k+ M

g =

1
2k + M
1
1+k+ M

k 1
1
1+k+ M

and

This leads to the policy

x =
The overall per capita contribution is

k
1
t =
b +
g =
1+k
1+k

4k
1+k

1+k

1
M
1
+M

The eect of population size (changing M ) depends on k. When k = 1 (the two

groups are of equal sizes), population has no eect either on per capita contributions
or on the outcome. When k > 1 (liberals are more numerous), an increase in
population size causes each liberal to give less and each conservative to give more.
The resulting policy becomes more conservative. When k < 1, the opposite occurs.
4k
It is easy to check that 1+k
1 + k for k > 0, with equality only when k = 1, from

which it follows that t declines with M (except when k = 1, in which case it is

2c
2kc
constant). Limiting contributions are 1+k
for liberals, 1+k
for conservatives, and
4kc
;
(1+k)2

the limiting policy is

(k 1)c
1+k .

62

v. The result does not hold. Fixing the total contributions of the other group, a
groups per capita contributions would indeed go to zero as population increases,
just as in a standard public goods problem. However, in equilibrium, the total
contributions of the other group rises. Competition between the groups keeps the
marginal benefit of contributions for the typical individual, and hence per capita
contributions, bounded away from zero.
vi. The equilibrium is inefficient because it involves osetting contributions by liberals
and conservatives. For the case of M = N , the equilibrium is x = 0. The most
efficient way to achieve this involves zero contributions by everyone.
b)

i. The efficient outcome involves no contributions and x = 0. Every player receives

a payo of c2 . The best response to this, for either a liberal or a conservative,
is to contribute c/2. In that case, the associated payo is c2 /2. In the static
Nash equilibrium, the policy is x = 0, and each individual contributes c, so everyone
receives a payo of 2c2 . Consequently, an equilibrium prevails as long as
c2

2c2

c2
2

We can rewrite this as

1
3
ii. Population size is irrelevant. It doesnt aect the static equilibrium, the efficient
outcome, or the gains associated with deviating from the efficient outcome.
84.

a) Rewrite utility as U (e, y t(y g) g f ) = U (e, y(1 t) + tg e) since e = f + g. Now

note that this expression is maximized when f = 0 and e = g. Therefore the problem is
maxe U (e, y(1
FOC yields

U1
U2

=1

b)

e)(1

e(1

t))

t.

In the case when U (e, c) = ec,

c = (y

t)

t) we get c =

U1
U2
(1 t)y
2

c
e

=1

and e =

t. Together with the budget constraint

y
2.

i. The strategy for the school is: e 2 R+ , and for the families: G : R+ ! R+ .
ii. Let e be the level set in the first period, and let g be the level of contribution of
other families. Then f = e [( NN 1 )g + ( N1 )g].
U (e , (1

t)(y

g)

f ) = U (e , (1

= U (e , [(1

t)y

t)y

(1

e + (

t)g

)g ] + g[

e + [(
1
N

(1

N
N

)g + (

1
)g])
N

t)])

We therefore have two cases to consider:

Case (i), N1 < 1 t, giving nothing is dominant strategy;
Case (ii), N1 > 1 t, giving e is dominant strategy.
In case (i), now consider the first stage, maximizing U (e, y(1 t) e) with respect
y(1 t)
1
to e yields FOC U
and
U2 = 1. For the specific case U = ec, we have c =
2
e = y(12 t) ;
In case (ii), the first stage is identical to part (1).
In case (ii), they are the same;
63

In case (i), not the same. In the parametric case we solve explicitly, there is generally less education in the non-cooperative solution, though the level of private
consumption is the same.
In case (ii), the non-cooperative solution is identical to the cooperative solution in
the stage game, so the cooperative solution is trivially sustainable for all value of .
So below we focus on case (i).
c)

i. The stage payo from cooperation is ( y2 )( (1 2t)y ) = (1 t) y4 , and the stage payo
2
from the static Nash is (1 t)2 y4 . Best deviation from cooperative outcome is to
y
set g = 0, which gives stage payo of ( y2 )[(1 t)y 2N
] = (1
2
Therefore best gain from deviation is y4 ((1 t) N1 ).
The incentive constraint for no profitable deviation is then

y2
((1
4

1
)(
N
1

t)
1 t
1 t2

Solving for , we get

1
N
1
N

)[(1

t)

y2
(1
4

t)y 2
4

(1

+ y4 ((1

t)

1
N ).

t))]

1
ii. As N ! 1, the threshold converges to 1+t
, which is decreasing in t. Therefore a
higher tax rate reduces the minimum at which cooperation is sustainable.

d)

i. The strategy set for families is the same as before. For the school, the strategy set
N +1
is R+ F where F consists of functions f : R+
! R+ .
ii. We need to solve for the education level that will be set in the third stage. Suppose
that in the second stage every family except one sets g , and one sets g, so f =
e [( NN 1 )g + ( N1 )g].
The (per family) payo for the N 1 family is:
e((y

g )(1

e+(

t)

N
N

)g + (

1
)g)
N

And the payo for the N -th family is:

e((y

g)(1

t)

e+(

N
N

)g + (

1
)g)
N

The schools objective is to maximize with respect to e:

(N 1)e((y g )(1 t) e+(

N
N

)g +(

1
N 1
1
)g)+e((y g)(1 t) e+(
)g +( )g)
N
N
N

FOC gives (N 1)[(y g )(1 t) e+( NN 1 )g + N1 g]+[(y g)(1 t) e+( NN 1 )g +

1
1
(N 1)e e = 0, which yields e = y(12 t) + 2N
[(N 1)g t + gt].
N g]
For large N , this converges to e (g ) = y(12 t) + gt
2 , which is invariant in g and
each family will take as fixed when making decision on g in the second stage. The
consumption for the family who sets g (when every one else sets g ) is
c = (y

g)(1

t)

e (g ) + (

N
N

)g +

1
g
N

Which converges to c = (y g)(1 t) e (g ) + g as N ! 1, so the optimal choice

of g is to set g = 0.
Therefore, an equilibrium involves g = 0.
64

iii. This solution is the same as in case (i) in the previous case where the schools promise
is binding. There is no dierence because in either case the school can simply set
the appropriate tuition level to achieve the desired education level.
85.

a) People like their friends to hear the secret and receive for every friend that hears
(including themselves). People do not like their enemies to hear and receive for every
enemy that hears.
For the next questions, I will use the notation T for a playing telling, and NT for a
player not telling. When there are multiple players, I will list player 1s strategy, then
player 2s strategy, etc. when writing equilibrium strategies.
b) {T,NT} is player 1s strategy set. T is dominant. Therefore, the only SPNE is {T}.

c) Using the same logic as in (b), 2 must tell 3 in the final subgame. Therefore, it is better
for 1 to not tell 2. So, the only SPNE is {NT,T} (note that player 3 has no decision
here). This is also the unique NE.

d) Using the same logic in (b), 3 must tell 4 in the final subgame. Using the same logic
as in (c), 2 must not tell 3. Therefore, it better for 1 to tell 2. So, the unique SPNE
is {T,NT,T}. There are 3 NE: {T,NT,T},{NT,T,NT},{NT,T,T}. In the last 2 NE,
player 2 makes a uncredible threat (not really a threat because it hurts him) to tell 3,
even though that would not happen in a SPNE. 3 can choose either strategy as he will
never play it in equilibrium and it does not aect the others decisions.
e) Using the logic above, we know that in a SPNE with n players, player n-1 must tell
player n. But, then player n-2 will not tell player n-1. Then, player n-3 will tell player
n-2. Then, player n-4 will not tell player n-3 and so on. Therefore, the SPNE is:
if n is even: {T,NT,T,NT,...,T,NT,T}
If n is odd: {NT,T,NT,T,...,T,NT,T}

f) Here is the general logic to solve this problem:

Person n-1 will definitely tell person n.
Then, person n-2 will tell person n-1 as long as > .
If the above is true, person n-3 will tell person n-2 as long as > 2 .
If the above is true, person n-4 will tell person n-3 as long as > 3 .
...
If the above is true, person n-i-1 will tell person n-i as long as > i .
This suggests the following end to this chain. We find the lowest i such that < i .
Call this i . Then, everyone from n i to the n 1 guy will tell. The n i 1 guy
will not tell.
Now, consider the n i 2 guy. He is like the n 1 guy above and will always tell
the n i 1 guy.
Then, person n i 3 will tell person n i 2 as long as > .
If the above is true, person n i 4 will tell person n i 3 as long as > 2 .
If the above is true, person n i 5 will tell person n i 4 as long as > 3 .
...
Etc.
So, this suggests the following answer. The strategies will take the following form with
n players.
Players n i to n 1 will tell.
65

g)

86.

Player n i 1 will not tell.

Players n 2i 1 to n i 2 will tell.
Player n 2i 2 will not tell.
etc. (continuing in groups of i players telling and then one player not telling)
So, they will look something like: {...T, ..., T, N T, T, ..., T, N T, T...T }

i. We have a situation in which we have 1 SPNE (and NE) outcome of the stage game.
Therefore, there is no way to get any other strategies played in a finitely repeated
game.
Intuitively, this is true because of backward induction. In the final stage game, 2
will definitely tell 3 if he is told. Therefore, 1 will never tell 2 in the final stage
game. But, then, in the second-to-last stage game, 1 cannot provide any incentive
(in the form of reward and punishment) for 2 not to tell 3, as 2 knows that 1 will
never tell him the secret in the final subgame. But, then, 1 will never tell 2 in the
second to last subgame. But, this logic continues backward through all of the stage
games.
ii. Without any monitoring, 1 can only condition his strategy on *his* previous strategies, not player 2s strategies. If this is the case, there is no way for 1 to provide
any punishment based on player 2s actions, so we cannot get the secret told.
iii. Here, we might be able to get the secret told. Note that Nash Reversion is the
harshest punishment possible. Consider the following strategies:
Player 1:
If ever received a signal that player 2 has told, play NT.
If not, play T.
Player 2:
If 1 ever played NT in the past, play T if told.
If not, play NT.
The question is if these strategies can be sustained. Consider player 1. If player 2
plays this strategy, player 1s strategy is a BR regardless of p and . Now, consider
player 2. Consider a one-period deviation to tell (remember, we only need to check
the 1 step deviation here as the situation is the same every period).
If he tells, he get 1 (from player 1 knowing) +1 (from player 2 knowing) + 1 (from
player 3 knowing) today. Tomorrow, with probability p, 1 will have seen that he
told and stop telling him. Then, he will only get 1 every period (from player 1
knowing). With probability 1 p, he will get 2 every period. If he does not tell,
he gets 2 for every period.
So, we need that: 3 + p 1 + (1 p) 12 1 2
1
Solving this gives us:
1+p
This makes sense - as p ! 0, we need serious patience ( ! 1) to get cooperation.
As p ! 1, we need the patience ( ! 12 ) required with full monitoring to get
cooperation.

a) If = 1, B is never chosen by nature, so we can eectively wipe out that branch. The
game reduces to the centipede game and unravels, with players choosing stop at each
node. If = 0, we wipe out the A branch, and players choose continue at every node.9
From this point on, we restrict attention to 2 (0, 1).

Note that if 2 {0, 1}, another school of thought is to apply equilibrium analysis to the full extensive form,
resulting in additional, peculiar equilibria. However, these results are not meaningful and are ignored.

66

There are 2 proper subgames, rooted at 1s final decision nodes. Subgame perfection
requires that player 1 of type A will choose s and type B will choose c. We are left with
solving the NE of the reduced game, which has normal form:
s
ss
,1
sc 1, 4 3
cs 0, 1 + 3
cc 1
,4

c
,1
3 2 ,6 5
3 ,1 + 2
3, 6 3

where 1s strategy gives his action when A and when B. Since 2 (0, 1), strategies ss
and cs are strictly dominated. This should also be clear from the extensive form, as type
B would never play stop. Thus, we have reduced normal game
s
sc 1, 4
cc 1

3
,4

c
2 ,6 5
3, 6 3

When

2 (0, 23 ), the game is dominance solvable, with unique NE (cc, c). Thus, we have

2
(cc, c)
2 0,
.
(29)
3

When

= 23 , the unique class of NE is

2
cc, s with prob p
3

When

2
= .
3

2 ( 23 , 1), there is a unique NE, which is a strictly mixed NE:

3
2
2 2
2
1
2
sc +
cc, s + c
2
,1 .
3
3
3

(30)

(31)

b) Notice that in each of the SPNE, the information set with 2 elements is reached with
positive probability. Hence, all of the SPNE are also SE, where the beliefs for 2 are
calculated from the strategies via Bayes Law.
Finally, notice that as ! 1, player 1 of type A will play stop with high probability.
However, should 2 get a chance to play, he still mixes between c and s - no unravelling!
This may seem surprising, as ex-ante, 2 assumes he is facing a type A player who would
play stop at the last node. But since in eqm, type A players immediately choose stop with
such high probability, if the game ever reaches 2s decision node, 2s ex-post probability
on A is significantly lower - low enough to justify playing either s or c!
87. Technical note: The PBE concept does not have as much bite as we would like in this problem
(in particular regarding beliefs following rejection of oers not made in eqm.) However, under
the sequential equilibrium concept, for some choices of there are no pure strategy SE, only
mixed. Thus, we pick the lesser of two evils and use the PBE concept, solving for all eqa,
including those involving unreasonable beliefs.
a) A strategy for the seller is a first period oer O1 and a second period contingent oer
O2 (O1 ) for each possible O1 rejected in period 1. A strategy for a buyer of type vi is
67

a plan b1 (O1 , vi ) accept/reject each oer O1 , and a second period plan b2 (O1 , O2 , vi ) to
accept/reject O2 when O1 was the (rejected) first period oer. We also need beliefs for
the seller after his first period oer is rejected.
(O1 ) = probability seller assigns to buyer having type vH .
Thus, our equilibria take the form
[O1 , O2 (O1 )], [b1 (O1 , vi ), b2 (O1 , O2 , vi ), (O1 )].
Claim 1.

accept if O2 vi
reject otherwise

A if
R if

b2 (O1 , O2 , vi ) =

In period 2, the buyer is sequentially rational and accepts only oers his value.
Claim 2. O2 (O1 ) 2 {vL , vH }
Given buyers period 2 behavior, sequential rationality ) seller names
(
vH if (O1 ) vvHL
O2 (O1 ) =
vL if (O1 ) < vvHL
Claim 3.
b1 (O1 , vL ) =

O1 vL
O1 > vL

Type vL buyer, should he reject, anticipates price vL or vH in period 2, and thus 0 profit.
Thus, he takes what he can get in period 1.
Claim 4. Define v vH (1
) + vL .
8
A if O1 v
>
>
<
A if O1 2 (v , vH ) and O2 (O1 ) = vH
b1 (O1 , vH ) =
R if O1 2 (v , vH ) and O2 (O1 ) = vL
>
>
:
R if O1 > vH .

Type vH buyer, should he reject, anticipates price vL or vH in period 2, and thus, profit
at best (vH vL ). Thus, vH accepts any oer with vH O1
(vH vL ) , O1 v .

vH clearly rejects O1 > vH . But if O1 2 (v , vH ), vH s choice depends on the sellers

strategy. If the seller will oer vH next period, it is worth accepting O1 now. Otherwise,
if the seller will oer vL , it is worth it to wait.
Thus, we have the buyers strategy fully characterized in terms of the sellers strategy.
Now lets work on the sellers strategy.
Claim 5. In eqm, seller never oers O1 < vL .
Such an oer will be accepted by all parties, so he does better to oer vL instead.
Claim 6. In eqm, the seller never oers O1 2 (vL , v ).
Such an oer will be accepted by all the high types and rejected by the low types.
Sequentially rationality would require naming vL in period 2. But then the seller does
better to name v in the first period, followed by vL in the second period.
Claim 7. In eqm, the seller never oers O1 2 (v , vH ].
If type vH accepts this oer in eqm, then upon rejection, the seller believes he is facing
type vL and names vL in the next period. But this contradicts claim 4. If type vH rejects
68

this oer in eqm, by claim 4, the seller must oer vL upon rejection. But then he does
better to name vL in the first period!
Thus, we have O1 = vL , OL = v , or OL > vH . Lets look for eqa in which...
Case 1: O1 = vL In such an eqm, both vH and vL types will accept in the first period,
yielding profit vL for the seller. We must rule out profitable deviation to (i) O1 < vL
(ii) O1 2 (vL , v ] (iii) O1 2 (v , vH ] and (iv) O1 > vH .
O1 < vL will be accepted by both types and yields lower profit that vL .
O1 2 (vL , v ] will be accepted by vH types, by claim 4, and rejected by vL s. Since such
an O1 is o the eqm path, beliefs (O1 ) are unrestricted by Bayes law.10 Therefore, we
require
vL
O1 + (1
) max[vL , (O1 ) vH ] 8O1 2 (vL , v ].
(32)
(32) should be thought of as a restriction on o-the-equilibrium-path beliefs, which in
turn pin down the sellers o-the-equilibrium-path actions O2 (O1 ). Note that by choosing
O1 = v , (32) yields
vL

v + (1

)vL

vL
.
vH

v + (1
)vL is the minimax11 payo from deviating to O1 2 (vL , v ] and thus,
vL
vH is a necessary condition for this case.
O1 2 (v , vH ] will be rejected by vL types. Should type vH accept O1 , by claim 4, we
must have O2 (O1 ) = vH . Should vH reject O1 , by claim 4, we must have O2 (O1 ) = vL .
The seller will never deviate to an O1 that will be rejected by vH types, as that would
yield profit vL < vL . He will prefer not to name any O1 2 (v , vH ] that will be accepted
by vH s when
vL

O1 + (1

8O1 2 (v , vH ] with O2 (O1 ) = vH .

)vH

(33)

Notice that we could certainly have b(O1 , vH ) = reject, O2 (O1 ) = vL 8O1 2 (v , vH ], so

that the minimax payo from deviating is vL .
O1 > vH will be rejected by all buyers. Beliefs O2 (O1 ) are unrestricted. Thus, we require
vL

max[vL , (O1 ) vH ]

8O1 > vH

(34)

Here the minimax payo from deviating is vL .

Therefore, provided vvHL , there exist eqa of the form
Buyers strategy:
Sellers strategy:

Satisfies claims 1,3,4 and condition (33)

O1 = vL , O2 (vL ) = vL
o-eqm path beliefs and actions satisfy claim 2, and (32), (33), (34).

Case 2: O1 = v . In this case, vH types accept and vL types reject. Therefore, we must
have O2 (v ) = vL so that seller profit is v + (1
)vL . For this to be an eqm,
our no-profitable deviation conditions are given by (32), (33), (34), where on the LHS of
each inequality, vL is replaced by . Additionally, we require that vL is not a profitable
deviation:
vL
vL ,
.
vH

10

Notice that this allows for unnatural concepts, such as the seller believing he can oer O1 , which vH types would
all accept, but also believing that if it is rejected, he will face type vH with certainty. Such beliefs are ruled out by
the sequential equilibrium concept.
11
That is, the smallest payo the optimal deviation in the class could yield.

69

vL
vH ,

Therefore, provided
Buyers strategy:
Sellers strategy:

there exist eqa of the form

Satisfies claims 1,3,4 and condition (33)

O1 = v , O2 (vL ) = vL
o-eqm path beliefs and actions satisfy claim 2, and (32), (33), (34).

Case 3: O1 = O1 > vH . In this case, the first period oer will be rejected. Note that
we cannot have O2 (O1 ) = vL , or else the seller would do better by naming vL in the
first period. Hence, O2 (O1 ) = vH , yielding profit vH . For this to be an eqm, our
no-profitable-deviation conditions are given by (32), (33) and (34), where on the LHS of
each inequality, vL is replaced by . The condition that v is not a profitable deviation
is
vL
,
.
(35)
(2
1)vH
That vL is not a profitable deviation:

which follows from (35).

Therefore, provided

(2

vL
1)vH ,

vL

vL
vH

(36)

there exist eqa of the form

Buyers strategy:
Sellers strategy:

Satisfies claims 1,3,4 and condition (33)

O1 = O1 , O2 (O1 ) = vH
o-eqm path beliefs and actions satisfy claim 2, and (32), (33), (34).
This completes our characterization of PBE in this problem.
b) Technical note: Here we use the sequential equilibrium concept. This greatly simplifies
the solution. In particular, it ensures reasonable beliefs following rejection of oers not
made in equilibrium.
For this problem, we use the assumption that 2vL < vH . (The solution is more interesting
in this case.)
The forms of strategies and beliefs are the same as in part (a).
We first work with the buyers strategy:
Claim 1. Identical to claim 1 in part (a).

accept if O2 vi
b2 (O1 , O2 , vi ) =
(37)
reject otherwise
Claim 2. O2 (O1 ) 2 [vL , vH ]
Follows from buyers period 2 behavior and sequential rationality of seller.
Claim 3. In period 1, buyers use cutos.
In particular, the component b1 (O1 , vi ) of is strategy can be represented as v (O1 ), so
that

accept if vi v (O1 )
b1 (O1 , vi ) =
reject if vi < v (O1 )
Let O2 (O1 ) be the period 2 component of the sellers eqm strategy. Consider buyer with
type vi facing O1 . If O1 vL , the buyer must accept, since by claim 2, he anticipates
an oer
vL in the next period. O1 > vH must obviously be rejected. Consider
O1 2 (vL , vH ]. If O1 O2 (O1 ), there is no point in waiting for the higher oer in the
second period, so he buys if vi O1 . If O1 > O2 (O1 ), he prefers O1 over O2 (O1 ) when
70

vi O1
(vi O2 (O1 )), or vi O1 1O2 (O1 ) v(O1 ). Observe that v(O1 ) > O1 , so that
any buyer who prefers O1 to O2 (O1 ) will in fact accept O1 .
Hence:
8
vL
if
O1 vL
>
>
<
O1
if O1 2 (vL , vH ] O2 (O1 ) O1
v (O1 ) =
(38)
min[
v
(O
),
v
]
if O1 2 (vL , vH ] O2 (O1 ) < O1 .
>
1
H
>
:
vH
if
O1 > vH .

Claims 1 and 3 give the buyers strategy in terms of the sellers strategy.
Now lets work on the sellers oer O2 (O1 ).
Consider O1 > vL . Note that not all buyers will accept O1 . Hence, we can pin down
the sellers beliefs (O1 ) by identifying the types that reject O1 , using Bayes Law.12
Since buyers use a cuto strategy, following O1 , the seller must have uniform beliefs
U [vL , v (O1 )]. Given such beliefs, the seller solves
max

O2 2[vL ,v (O1 )]

which has solution

O2 (v (O1 )

O2 )

v (O1 )
O2 (O1 ) = max vL ,
.
2

(39)

Notice that this rules out O2 (O1 ) O1 , thereby simplifying (38).

Now (38) and (39) constitute a (somewhat complicated) system involving v (O1 ) and
O2 (O1 ). Solving simultaneously yields
O2 (O1 ) v (O1 )
When
When
When

12

O1 2 (vL , (2
O1 2 (2
O1 >

)vL ]
)vL , 2 2 vH

vH

vL
O1
2
vH
2

O1
1

vL

2O1
2

(40)

vH

Here we have used 2vL < vH . Otherwise, there would be no middle case. Note that the
middle case corresponds to an interior cuto for the buyer and interior O2 for the seller.
For O1 vL , we have that all buyers will accept, so v (O1 ) = vL . However, beliefs
(O1 ) are then unrestricted, even under the sequential equilibrium concept.
Finally, since we have pinned down the outcome following each O1 , we identify the
equilibrium choice of O1 as the O1 that maximizes the sellers profit.
Profit is then given by
8
>
>
>
O1
when O1 vL
>
>
>
>
>
>

v (O1 ) vL
>
1)
<
O1 vHvHv v(O
+
v
when O1 2 (vL , (2
)vL ]
L
vH vL
L
(O1 ) =
(41)
>

(O )
(O ) O (O )
>
v
v
v
O
2
1
1
2
1
H
1
> O1
+ 2
when O1 2 (2
)vL , 2 vH
>
vH vL
vH vL
>
>
>
>
>
>
:
v2H vvHH /2
when O1 > 2 2 vH
vL

Even for O1 o the eqm path! This is where the sequential equilibrium concept is essential.

71

Assume additionally that vH > 4vL . It can then be verified that the optimal O1 lies in
the range O1 2 (2
)vL , 2 2 vH .13
Solving the profit maximization problem yields
O1 =

vH (2
)2
.
2(4 3 )

Combined with (37) and (40), this characterizes our sequential equilibrium.
88. Ps(9-3)
89. Ps(9-4)
90.

dw
a) No. For type A, dw
de U = 2e. For type B, de U = 1. Notice that the type Aindierence
curve can be either shallower or steeper than the type Bindierence curve depending on
whether e 7 12 .

b) In equilibrium, wi = i . For separation, we need

H

e2

and
e

(where edenotes the education level for type H). The first condition tells us that
e2 H L , or e (H L )1/2 . The second tells us that e H L . Thus, we can
construct a separating equilibrium by having type Hworkers choose any esatisfying
L e (H

When H L < 1, this set is non-empty.

there are no separating equilibria.

If H

L )1/2
L > 1, the set is empty, and so

c) Separation now requires

H

e2

L (ICHL )

and
e

d (ICLH )

(where e and d denote levels for type H). Then the two constraints become
H

d e (H

d)1/2

So we can choose any d such H L d 2 [0, 1], and then choose e to satisfy the
previous condition.
Clearly, for any d, we want to take eas small as possible, so e = H L d. The payo
for type His then
H e2 + (e H + L ) = L + e e2
13

Check that when vH > 4vL we have

arg

max

O1 2[vL ,(2

)vL ]

(O1 )

72

= (2

)vL .

Let us maximize this over e. The first order condition is 1 2e = 0, or e = 12 . So the

best equilibrium for type Hinvolves e = 12 and d = H L 12 .
From the preceding, the equilibrium payo for type His L + 14 . This is invariant with
respect to H . The intuition for this is that Hs maximal utility is constrained by ICLH ,
and therefore is determined by L rather than H.
91. We assume that d >> c.14 In this game, a strategy for player i is a sequence of actions. The
action in time t = 1, 2, 3... is is decision clap/not clap should i find that both players have
chosen to clap in every period up to and including t 1.
Possible actions for A and B in period t can be described by the following matrix:
N
Mix
C
N
I
II
III
Mix IV
V
VI
C V II V III IX
We narrow down the set of eqa by the process of elimination.
a) Claim: There is no eqm where in each period, players clap with probability 2 (0, 1).
Proof: Suppose the contrary. Then all information sets are reached with positive probability, so beliefs are determined by Bayes Law. Let t be the probability A places on
player B being crazy at the beginning of period t. Notice that 1 = .
Let ptA and ptB be the probability placed on C in t by A and B respectively. Since
players strictly mix in each period, the expected (continuation) payo in each period
from clapping is 0. For B to be indierent between C and N in period t, we require
c + (1

pt )d + p 0
{zA
}

t )(1
{z

0
|{z}

payo from not clapping

payo from clapping

which yields ptA = d d c , independent of t. For A to be indierent between C and N in

period t, we require
|

c + (1

which yields ptB = 1

We can now calculate

t+1 =

ptB )d
}

payo from clapping

c 1
d 1 t .
t+1 from

0
|{z}

payo from not clapping

t using Bayes Law as follows:

t
=
+ (1 t )ptB
t + (1

t ) 1

c 1
d 1 t

d
d

t .

Thus, such an equilibrium would require beliefs that increase geometrically, which is
impossible because we must have 2 [0, 1].
Therefore, no such strictly mixed equilibrium exists.
14

In particular, we require d > 2c. Notice that if d 2 (c, 2c), there is an eqm where actions at t = 1 are (C, N ) and
(N, C) thereafter. If d < c the unique eqm is to never clap.

73

b) Claim: In no period will B choose the pure action stop clapping.

Proof: Suppose the contrary - that there exists an eqm in which B plays stop clapping
in t. Then in period t + 1, A must have beliefs t+1 = 1.15 Hence, in period t + 1, A
must choose N . But then it is profitable for B to deviate to C in period t, because C
yields d 2c > 0. Hence, the proposed strategy profile cannot be an eqm.
c) Claim: In any eqm, B wins the prize with certainty.
We prove this using a series of further claims.
Claim: In no eqm do both players have strictly positive payo.
Proof: If there were such an eqm, it cannot involve placing probability on N in t = 1.
Hence, we have (C, C) in period 1. But then continuation payos at t = 2 must be
positive for each player, so we have (C, C) in period 2. Induction pins down strategies
as (C, C) in each period, which is clearly not an eqm.
From this claim, it follows that in no period can actions be (C, C).
Claim: If in period t, actions are (N, C), then in period t 1, actions must be (N, C).
Proof: Given period t + 1 actions, in period t, C yields a minimum of d 2c > 0 for B,
so B must choose C. For A, C yields c, so A must choose N .
Hence, if in any period, actions are given by (N, C), then so too are period 1 actions, so
that B wins the prize with certainty. Henceforth, we restrict attention to eqa where in
no period do we have actions (N, C).
Claim: Period t actions are never (N, mix).
Proof: This is obvious, as otherwise B could deviate in t by playing C.
We have now narrowed down the set of possible actions in each period t:
N Mix
C
N

Mix
V
VI
C
V III
In any eqm where actions in each period are given by V, V I or V III, every information
set is reached with positive probability. Hence, the sequence t is (weakly) increasing
in t. By an argument similar to (a), there can only be finitely many periods where the
actions are given by either V or V III. Thus, we are left with an equilibrium with a tail
in which actions are given by V I. But this eqm cannot be subgame perfect, as this tail
clearly does not constitute an eqm.
Therefore, upon eliminating all equilibria that include (N, C) at t = 1, we have none
remaining. It follows that any equilibrium must involve (N, C) in period 1, which proves
the claim.
92.

a) For S, a strategy is an element of {D, N D}3 (it specifies D or N D for each of the three
values). For B, a strategy is an element of [0, 1]4 (it specifies a quantity for each
possible disclosure, and for nondisclosure).
b) B chooses q to solve maxq 0 E{(v 1)q q 2 }, which is the same thing as maxq
1
The solution is q = E(v)
. This is also the payo for S.
2

[E(v)

1] q

c) For any completely mixed strategy profile, the posterior upon observing disclosure of v 0
attributes all probability to quality v 0 . So any limiting belief also attributes all probability to quality v 0 . The consistency requirement specifies that a sequential equilibrium
15

Here we have invoked the sequential equilibrium concept.

74

q2 .

must use a limiting belief. The same is not true of Perfect Bayesian Equilibrium, since
this allows for any belief o the equilibrium path.
d) In any sequential equilibrium, v2 and v3 are definitely disclosed, while v1 may or may
not be disclosed (its irrelevant). Heres why.
Claim #1: S will choose the action associated with the highest expected value of v,
according to the buyers beliefs. This follows from part B.
Claim #2: In any equilibrium where either v2 or v3 is not disclosed with certainty, v1
is definitely not disclosed. Consider any sequential equilibrium where either v2 or v3
is not disclosed with certainty. Following non-disclosure, the buyers inference must be
E[v | N D] > v1 (since some weight is placed on either v2 or v3 , or both). Following
disclosure, the buyers inference must be v1 (either because v1 is disclosed with positive
probability, or by part C). So non-disclosure of v1 is strictly better (by claim #1).
Claim #3: In any sequential equilibrium, v3 is disclosed with probability 1. Suppose
not. By claim #2, v1 is not disclosed, so E[v | N D] < v3 . Suppose the seller learns
that quality is v3 . Following disclosure, the buyers inference is v3 (either because
v3 is disclosed with positive probability, or by part C); following non-disclosure, the
buyers inference is E[v | N D] < v3 . So disclosure is strictly better (by claim #1), a
contradiction.
Claim #4: In any sequential equilibrium, v2 is disclosed with probability 1. Suppose not.
Then, by claim #2, v1 is not disclosed, and, by claim #3, v3 is disclosed, which means
E[v | N D] < v2 . Suppose the seller learns that quality is v2 . Following disclosure, the
buyers inference is v2 (either because v2 is disclosed with positive probability, or by part
C); following non-disclosure, the buyers inference is E[v | N D] < v2 . So disclosure is
strictly better (by claim #1), a contradiction.
e) Claim #1 from part D still applies. Moreover, since v2 and v3 are not disclosed with
certainty (since S doesnt necessarily observe them), we have a stronger version of claim
#2: v1 is definitely not disclosed in any sequential equilibrium. Claim #3 also remains
valid (in fact, one no longer even needs claim #2 to prove it). So the question is whether
the seller will disclose v2 . We will identify conditions for which there is an equilibrium in
which v2 is disclosed, and for which there is an equilibrium in which v2 is not disclosed.
First, consider a sequential equilibrium in which v2 = 4 is disclosed. Then, applying
Bayes rule,
Pr [v1 | N D] =

1
3

1
3

2 13

1
1+2

Pr [v2 | N D] = Pr[v3 | N D] =
and

1
3

1
3

+ 2 13

1+2

2+4 +9
2 + 13
=
1+2
1+2
From disclosing v2 = 4, S receives a payo of 4. From not disclosing v2 = 4, S receives
2+13
a payo of 2+13
1+2 . Accordingly, disclosure is optimal provided that 4
1+2 , which
requires 0.4.
Next consider a sequential equilbrium in which v2 = 4 is not disclosed. Then, applying
E[v | N D] =

75

Bayes rule,
Pr [v1 | N D] = Pr[v2 | N D] =
Pr[v3

N D] =

and
E[v | N D] =

2 13

1
3

2 13 +

1
3

1
3

1
3

1
2+

2+

2+4+9
6+9
=
2+
2+

From disclosing v2 = 4, S receives a payo of 12 (4 1). From not disclosing v2 = 4, S

receives a payo of 12 ( 6+9
1). Accordingly, non-disclosure is optimal provided that
2+
1
1 6+9
1) 2 ( 2+
1), which requires
0.4.
2 (4
We conclude that S discloses v2 = 4 when 0.4, and doesnt disclose it when
0.4.
93.

a) Yes: along an indierence curve,

than for i = H.

dw
de

= c0i (e), which by assumption is greater for i = L

b) eL = 0; from the non-imitation conditions, eH = cL 1 (H

c)

eP

2
where

[0, e ]

L ), and eH = cH1 (H

L ).

where
= cL [ (H L )] (from the type L non-imitation condition),
is the fraction of type H workers.
e

d) Equilibrium dominance (the intuitive criterion) isolates the most efficient separating
equilibrium.
e)

i. For the separating equilibria, the conditions change to

cL (eH ) + teH = H

cH (eH ) + teH = H

and
For the pooling equilibrium, the formula for e changes to
cL (e ) + te = (H

L )

ii. Using the equation that defines eH ,

deH
=
dt
Therefore,

Moreover,
f)

eH
t + c0 (eH )

0
c (e ) c0L (eH )
dUH
= eH H 0H
<0
dt
cL (eH ) + t
dUL
dt

= 0.

i. None of the conditions change from part (e)

ii. The eect on utility is the same as the eect from part (e-ii), plus the eect of the
change in the lump-sum transfer. For the lump-sum transfer, we have a per capita
revenue (and hence per capita lump-sum payment) of R = et. Therefore,
0

cL (eH )
dR
= e 0
>0
dt
cL (eH ) + t
76

dR
L
Therefore, dU
dt = dt > 0. As for the type H workers, we add the lump-sum eect
to the eect derived in part (e-ii):
0
c (e ) (1
)c0L (eH )
dUH
= eH H H 0
dt
cL (eH ) + t

For sufficiently close to unity, this is strictly positive. So if the fraction of type
H workers is sufficiently high, everyone will be better o with a higher tax.
94.

a) Given a price p1 , only buyers with type v p1 would accept such an oer. Probability
of sale is 1 p1 , and therefore, the expected revenue, (p1 ) = p1 (1 p1 ) is maximized
at p1 = 12 .
b)

i. If p1 < p2 , then for all v, v p2 < v p1 , and therefore, the buyer would never
be willing to buy the good in period 2. Therefore, the probability of sale in the 1st
period is 1p1 , and the probability of sale in the 2nd period is 0.
ii. Observe that for indierence to hold,vp1 = (
v p2 ), or v = p11 p2 . Note that v p1 .
Contrary to the wording of the question, it is not necessarily true that v 1, but
let us assume that it is. Given prices p1 , p2 , and valuation v, let U (v, p1 , p2 ) =
(vp1 )( (vp2 )) = v(1 )p1 + p2 represent the incremental utility from buying in period
1 versus buying in period 2. Observe that U (v, p1 , p2 ) is strictly increasing in v; since
indierence holds for type v, then for a buyer with valuation v 2 (
v , 1), she would
strictly prefer to buy in period 1 over period 2. Moreover, since v > v p1 , such
a buyer prefers buying in period 1 to not buying at all. By similar reasoning, for a
buyer with valuation v 2 (p2 , v), she strictly prefers buying in the 2nd period to the
1st and to not buying at all.
iii. The expected revenue is
8
>
< p1 (1
p1 )
R(p1 , p2 ) =
p1 1 p11
>
:
p2 (1 p2 )

p2

+ p2

p1 p2
1

if p1 < 02
if p2 p1 1
if 1

+ p2

+ p2 < p1

iv. For any given p1 , observe that R(p1 , p1 ) = p1 (1p1 ). Note that for p2 2
d
dp2 R(p1 , p2 )

(42)

2 (p1 p2 )
1

p1 +

, p1 ,

> 0 and therefore, R(p1 , p2 ) < R(p1 , p1 ). Thus, for any

h

optimal solution, it must be that p2 62 p1 + 1 , p1 . Now consider any p2 2

0, p1 + 1 , p1 . Observe that R(p1 , p2 ) < R(p2 , p2 ), and therefore, p2 does not

lie in this range. This leaves us with p2
p1 , and so R(p1 , p2 ) = p1 (1 p1 ). We
know from earlier solutions that the optimal p1 = 12 . The buyer therefore buys in
the first period if v > p1 .
v. The payos are the same.

c) After the monopolist observes that no purchase was made at t = 1, she will deduce that
v is distributed [0, 14 ]. Therefore, it would be optimal for her to deviate and set p2 = 14 .
d) We shall now proceed to find a sequential equilibrium of this game.
i. p2 =

v
2 .

ii. It must be that v

p1 =

v
2

77

v
2 ,

or p1 = v

2
2

iii. We will assume that v 1, and will later verify this is true for the optimal v.
R(v ) = p1 (1 v ) + p2 (v p2 )

2
v
2

= v
(1 v ) +
2
2
iv. Taking the f.o.c with respect to v :

2
v
(1 2v ) +
2
2

= 0

v =
(2 )2
4(4 3 )
2
note that (24 3)

2
<1
4 3

This leads to an expected revenue of

To see how this compares to
revenue here is strictly less.

1
4,

< 1 since

< 1. Therefore, the

95. For the following answers, I will list player 1s strategy as (x, y), where x is his choice given
he is type 1 and y is his choice given he is type 2. I will list player 2s strategy as (w, z),
where w is his strategy given player 1 chooses L and z is his strategy given player 1 chooses
R. The beliefs of being at the top node of the information set reached after player 1 plays L
will be listed as . The beliefs of being at the top node of the information set reached after
player 1 plays R will be listed as .
a) Consider an equilbrium in which player 1 plays (R,L). This implies that = 0 and
= 1. Given these beliefs, player 2 must choose (u,u). Now, we check if player 1 wants
to deviate. Type 1 prefers to play R as it yields 2 vs. getting 1 from playing L. Type
2 prefers to play L as it yields 2 vs. getting 1 from R. Therefore, we have a set of PBE:
((R,L),(u,u), = 0, = 1).
Consider an equilbrium in which player 1 plays (L,R). This implies that = 1 and
= 0. Given these beliefs, player 2 must choose (u,d). Now, we check if player 1 wants
to deviate. Type 2 would deviate: he prefers to play L rather than R as he gets 2
instead of 1. Therefore, this cannot be a PBE.
b) Consider an equilbrium in which both types pool on L. This implies that = .5. Given
these beliefs (or any beliefs), player 2 must choose (u,-). If order for player 1 to not
deviate, player 2 must play d once R is played (otherwise type 1 wants to deviate). This
is sequentially rational for player 2 given that 3 2(1 ) => 25 . Note that we
are free to choose these beliefs as this information is o the equilibrium path. Therefore,
we have a set of PBE: ((L,L),(u,d), = .5, 25 ).
Is this a SE? Consider ((L,L),(u,d), = .5, = 14 ). In order to justify this as a SE, we
have to create a sequence of purely mixed behavior strategies for player 1 that approach
(L,L), such that the beliefs elicited by these strategies approach = 14 . Consider the
sequence in which type 1 plays L with probability 1 "n and R with probability "n
and type 2 plays L with probability 1 3"n and R with probability 3"n , with "n ! 0
as n ! 1. These strategies clearly converge to (L,L). The beliefs elicited by these
n
strategies are n = 3"n"+"
= 34 which clearly converges to 34 . Therefore, we have a SE.
n

78

c) Note that there are subgames here except the original game so the set of NE with equal
the set of SPNE. Consider the strategy profile ((R,R),(d,u)). I claim this is a NE and
therefore a SPNE. Consider player 1. Given that player 2 is choosing (d,u), (R,R) is a
best response for player 1 as both his types prefer R. For player 2, choosing d given player
1 chooses L does not aect his payo as this move is o the equilibrium path. For player
2, choosing u given player 1 chooses R is the best response as 12 (3) + 12 (0) > 12 (0) + 12 (2).
Therefore, we have a subgame perfect NE.
The key point of this problem is that this is NOT a PBE. Why? In order to justify
the equilibrium above, it is crucial that player 2 plays d given that player 1 plays L
(otherwise, if 2 played u, player 1s type 2 would deviate to L). However, there are no
beliefs at the information set reached after L that can justify this move. Sequential
rationality given ANY beliefs here will cause player 2 to play u at this information set.
Therefore, this is not a PBE.
d) Consider a situation in which type 2 plays L and type 1 purely mixes. It must be that
player 2 plays (u,u) regardless of level of mixing. However, then type 1 would prefer to
play R with probability 1 and therefore not fully mix. So, we do not have an PBE.
Consider a situation in which type 2 plays R and type 1 purely mixes. It must be that
player 2 plays (u,d) regardless of level of mixing. However, then type 2 would prefer
deviate and play L. So, we do not have an PBE.
e) Yes, consider the pooling equilibrium ((L,L),(u,d), = .5, 25 ). Player 2 justifies
playing d after R by believing that type 2 is more likely to deviate to R. However, type
2s equilibrium payo from playing L is 2. The most he can make by deviating to R is 1.
Clearly, he has no incentive to deviate. However, type 1 does have incentive to deviate
given that the reciever chooses u. Therefore, the intuitive criterion requires that = 1
when R is o the equilibrium path, eliminating this pooling equilibrium.
f) Not much.
Look at the answers to a - regardless of , the beliefs will remain the same as the types
separate in equilibrium - therefore the answer will hold.
Look at the answers to b - changing will change the beliefs = .5 to = but this will
not change the best response for player 2 given he sees L. Therefore, the only change is
that = .
96.
a) The president makes a decision based on the advice of the Economist (he has to decide whether to choose E or N given the economist says G or B). So, his
strategy set is {EE,NE,EN,NN}. If the Economist is knowledgeable, he must choose
what to say if he learns the program is good or bad. If the Economist is ignorant,
he must choose what to say (he never learns the state of the world). So, he has
three information sets with two choices for each - therefore, he has eight strategies
{GGG,BGG,GBG,GGB,BBG,GBB,BGB,BBB}.

b)

1
i. The president will see a message G with probability 16
(only when the state of
the world is good and the Economist is knowledgeable). He believes that the state
of the world is Good with probability 1 given he sees G. Given this, he enacts
the program.
31
3
ii. The president will see a message B with probability 15
16 . There is a 4 4 = 16 chance
that the Economist is ignorant and the program is Good (leading to a message of

79

B). Therefore, there is a

3
16
15
16

3
15

1
5

chance that the program is good given the

message B. Therefore, he will not enact the program.

iii. If the outcome is 1 (the president enacts and succeeded), the president must have
seen a message of G. He must believe that the Economist is knowledgeable with
probability 1. If the outcome is 0 (the president does not enact), the president must
have seen a message of B. He must believe that the Economist is knowledgeable
with probability

3
16
15
16

3
15

= 15 . We never see an outcome of -1, so we are free to set

beliefs.
iv. Consider the ignorant Economist. If he chooses to say B, he will get a payo of
1
5 . If he chooses to say G, the president will enact the plan. Therefore, he will
get a payo of 1 14 of the time (when the program is good) but he will get a payo
of ( 1) 34 of time (when the program is bad). There is no ( 1) 2 [0, 1] such that
he will want to say B. Therefore, we cannot have an equilibrium.
c)

i. The president will see a message G with probability 18 (only when the state of the
world is good and the Economist is knowledgeable). He believes that the state of
the world is Good with probability 1 given he sees G. Given this, he enacts the
program.
ii. The president will see a message B with probability 78 . There is a 12 14 = 18 chance
that the Economist is ignorant and the program is Good (leading to a message of
B). Therefore, there is a

1
8
7
8

1
7

chance that the program is good. Therefore, he

will not enact the program.

iii. If the outcome is 1 (the president enacts and succeeded), the president must have
seen a message of G. He must believe that the Economist is knowledgeable with
probability 1. If the outcome is 0 (the president does not enact), the president must
have seen a message of B. He must believe that the Economist is knowledgeable
with probability

3
8
7
8

= 37 . We never see an outcome of -1, so we are free to set beliefs.

iv. Lets set beliefs given an outcome of -1 at 0. Consider the ignorant Economist. If
he chooses to say B, he will get a payo of 37 . If he chooses to say G, he will
get a payo of 1 14 of the time (when the program is good) but he will get a payo
of 0 34 of time (when the program is bad). Therefore, he will want to say B.
It is easy to show that the knowledgable Economist will want to give good advice.
Therefore, we have an equilibrium.
Interpretation: If there are very few good Economists and only the good ones make
radical suggestions, it becomes very tempting for the bad Economists to make the
same suggestions to appear good, even if it sometimes exposes them as being bad.
As the number of good Economists rises, the bad Economists are happy to be
perceived as a near-average Economist by making conservative suggestions.
97.

a) Player A has just one information set. Player B has 4 information sets, 2 corresponding
to the selfish disposition and 2 corresponding to the egalitarian disposition. Within each
disposition, one of the information sets corresponds to player 1 undertaking the project
and the other information set corresponds to player 1 not undertaking the project. The
strategy set for player A is SA = {U, N U }, where U denotes undertake and N U
denotes not undertake. The strategy set for player B is SB = {(tu1 , tu2 , tnu1 , tnu2 ) :
tu1 , tu2 , tnu1 , tnu2
0}, where (tu1 , tu2 , tnu1 , tnu2 ) is a four-tuple of transfer, specifying
80

the transfer that the player makes in each of his four information sets.

b)

In any subgame perfect equilibrium the selfish Player B makes no transfers to Player
A. The egalitarian Player A transfers 60 to A in case the project has been undertaken
and 40 otherwise. Player A gets an expected payo of (1 )60 from undertaking the
project and 10 + (1 )50 from not undertaking. He therefore undertakes the project
if and only if 12 .
i. The strategy set for Player A is a function f : R+ ! {u, nu} were f (G) represents
As decision after receiving a gift of size g. A strategy for Player B is of the form
(g, t), where:

g : {e, s} ! R+ represents the gift that the the player oers A in case he is selfish
(s) and in case he is egalitarian (e).
t : {e, s} {u, nu} R+ ! R+ , where for example t(e, nu, g) represents the transfer
that B makes to A in case that the the project was not undertaken, B is egalitarian
and has made a gift of size g to A.
It is also correct to split B into two types and specify a strategy for each type.
ii. The egalitarian B is willing to make a gift of size g ge = 70. The selfish B is
willing to make a gift of size g gs = 30.
iii. Note that in any separating equilibrium, the selfish type cannot make any gift. If
such a separating equilibrium existed then upon revelation A would not undertake
the project and therefore the selfish B would rather deviate to making a gift of 0
(regardless of As actions). Given part ii), in any separating equilibrium we must
have 30 g 70. If g < 30 then the selfish type would find it profitable to
deviate to making a gift, and if g > 70 then the egalitarian type would find it
profitable to deviate to not making a gift. We resolve the indierence of the selfish
type at g = 30 by having him not make a gift and the indierence of the egalitarian
type at g = 70 by having him make a gift. It can be verified that A only finds it
worthwhile to undertake the project when g 50 (and finds it strictly worthwhile
when g < 50). There can be no separating equilibria in which the project is not
undertaken, since this would require g
50, and therefore a final payo to the
egaliatrian B of at most 40, so the egalitarian B would deviate to making no gift
and getting a payo of. To summarize, denoting the belief of Player A that Player B
is egalitarian after receiving a gift of size g by (g), we have the follwing separating
equilibria:
Let 2 [30, 50] are all equilibria:
Player 1s strategy: f (g) = nu 8g 30
f (g) 2 {u, nu} for g > 30, g 6= f () = u
Player 2s strategy: g(s) = 0 g(e) = .
t(s, x, g) = 0 8g, x 2 {u, nu}
t(e, u, g) = 60 g 8g 60
t(e, u, g) = 0 8g > 60 t(e, nu, g) = 40 g 8g 40
t(e, nu, g) = 0 8g > 40
81

Player 1s beliefs:(0) = 0, (g) 1/ 2 for g such that 0 < g < 30.

() = 1
(g) <= 1/2 or (g) >= 1/2 depending on whether f (g) = u or f (g) = nu for
g > 30, g 6=
iv. Since the project is undertaken in all separating equilibria when B rreveals himself as
e, and the final payos are always the same, they are all equally efficient. Efficiency
in this context just depends on whether the project is undertaken or not
v. In pooling equilibria in which the project is not undertaken (gifts have to be 0),
1
and such an equilibrium exists if and only if 12 as in part a). If
2 , we can
have pooling equilibria in which both types make a gift of size 2 [0, 30]. On the
equilibrium path, Player A believes that the player is egalitarian with probability
() = . O the equilibrium path we must have (g) 12 for all g < so that
after seeing a gift smaller than , Player A chooses not to undertake the project in
a sequentially rational fashion, and the Selfish Player B has no incentive to deviate
to a lower gift. Beliefs (g) for g > can be anything.
98.

a) First consider T = +1. Minmax payos are -5. The set of feasible individually rational
payos is given by the following constraints: min{u1 , u2 }
5, max{u1 + 3u2 , 3u1 +
u2 } 20. That is the sustainable payo set. For T finite, the static equilibrium is
unique, so the only subgame perfect outcome involves repetitions of (D, D).
b)

i. D is a dominant strategy for type A and C is a dominant strategy for type B, so

that is what they must play in any Bayesian equilibrum.
ii. because all types have dominant choices in the second (last) round, those are what
they must play regardless of beliefs. Thus, in the first round the players know that
their current choices do not aect future outcomes, so they can examine their first
round incentives in isolation. Both types have dominant choices in the first round,
so the only possible solution is: type A always plays D while type B always plays
C.
iii. a simple induction argument (based on the answer in part 2) implies that type A
always plays D while type B always plays C.

c)

i. Obviously type A must play its dominant strategy, D. Consider player i type B.
Regardless of what player j chooses, the dierence between i type Bs payo from
choosing C and his payo from choosing D is -5 if jis type A , and +5 if j is type
B. Therefore, C is a dominant strategy for i type B if < 12 , D is a dominant
strategy for itype B if > 12 , and both choices are equally good (regardless of what
j does) when = 12 . It follows that condition Y is 12 and condition Z is 12 .
There are no other Bayesian equilibria except when = 12 , in which case there are
also equilibria in which player i type B chooses C while player j type B chooses D.
ii. A. For type A, the payo is 5 + ( 5) + (1 )10 = 15 15. For type B, the
payo is 5 + ( 10) + (1 )5 = 10 15.
B. Let i (ai , aj ) denote the probability i assigns to j being type A when the first
period choices are (ai , aj ). We will choose i (ai , C) = and i (ai , D) = 1. The
strategies always prescribe D for player i type A in period 2, which is obviously
justified (for any beliefs about js type) because D is a dominant choice in period
2 for that type. The strategies prescribe C for player i type B in period 2 when
82

C.

D.

E.

F.

iii. A.
B.

C.

D.

E.

aj = C in the the first period, which is plainly optimal in light of part 3(a)
given than condition Y holds and i (ai , C) = . The strategies prescribe D for
player i type B in period 2 for all other first period outcomes (aj = D), which
is plainly optimal given that i (ai , D) = 1, since D is then a dominant choice
for that player type. Note finally that beliefs are derivable from the strategy
profile only when the first period choices are (C, C), in which case the posterior
probability that j is type A is indeed equal to the prior, .
whether or not a type deviates in the first period, she will clearly be better o
playing D in the second period. Thus the best deviation must be to D in the
first period followed by D in the second. Given the strategies, the resulting
payo is 10 5 = 5.
because condition Y is satisfied, player i type Bs most attractive two-period
deviation is to D in the first period followed by C in the second period. Given
js strategy, the resulting payo for i type B is [10 10] + (1 )[0 + 0] = 0.
For type A, we need 15 15 5, or 32 . For type B, we need 10 15 0,
or 23 . Both of these requirements are weaker than condition Y . Therefore,
we have a weak perfect Bayesian equilibrium i 12 .
This is a sequential equilibrium. Let "N
j (k)denotes a sequence of probabilities
(indexed by k) with which player j type N chooses D in the first round. By
A
constructing these perturbations such that "B
j (k)/"j (k) goes to zero as k (and
N
the "j (k)s) go to zero, we assure that the limiting posterior upon observing
jchoose Dplaces all weight on type A for type j. On the other hand, since
B
1 "A
j (k) and 1 "j (k) both converge to unity, the limiting posterior probability
that j is type A upon observing j choose C is . These are the beliefs that i
assigns.
For type A, the payo is 5(T 1) + ( 5) + (1 )10 = 5T + 5 15. For
type B, the payo is 5(T 1) + ( 10) + (1 )5 = 5T 15.
for any such history ht , let i (ht ) = 1. In that case, choosing D is a dominant
choice for both types in the current round, and according to the strategies future outcomes do not depend on current choices, so the prescribed choices are
justified.
no information is revealed (because both types have made the same choices),
so the belief must equal the posterior: i (ht ) = , where ht is the history for
which no one has played D.
A deviates, her opponent will always play D, so the best deviation for A is to
choose D in some period t0 with T > t0
t and all subsequent periods. Her
0
resulting payo will be 5(t 1) + 10 + (T t0 )( 5) = 10t0 5T + 5. Notice that
this in increasing in t0 ; therefore, her most attractive deviation (among those
considered here) is to switch to D in round T 1, in which case the resulting
payo is 5T 5.
once B deviates to D, her opponent will always play D, but given that condition
Y holds, that i (ht ) = , and that no further information will be revealed
concerning her opponents type, it will be in her interests subsequently to always
play C. Therefore, the best possible deviation by B in period t0 with T > t0 t
yields a payo of 5(t0 1) + [10 10(T t0 )] + (1 )0. Notice that this is
increasing in t0 ; therefore, the most attractive deviation among those considered
here is in t0 = T 1. The associated payo is 5T 10.
83

F. for type A, we need 5T + 5 15

5T
5, or 23 . For type B, we
need 5T 15
5T 10, or 23 . Both of these requirements are weaker
than condition Y . Also, condition Y directly rules out profitable deviations in
round T on the equilibrium path. Therefore, we have a weak perfect Bayesian
equilibrium i 12 .
G. Here we have assumed that i (ht ) = 1 if i alone has deviated. To see that this
is inconsistent with the strategies, focus on T = 2 and consider the argument
in part 3(b)(vi). When i alone has deviated, the posterior belief about j type
derived from any strictly mixed strategy close to the equilibrium strategy must
be that j is type A with probability close to . In that case, type A must choose
C in the second period (given that condition Y holds), which is contrary to the
strategies used here (but consistent with what we did in part (b)).

84