Midterm (take-home exam) May 10, 2017

1. Let F (t) be the distribution function of the length

of an individuals life in a group of population. The
F (t)
hazard rate () at time t is h(t) 1F (t) .
(a) Find the distribution function for the
constant hazard rate case h(t) = . (Hint: F (t)
satisfies a LCCDE. It is also a separable variable
DE. The initial condition is F (0) = 0.)
Consider a life annuity () that pays $ 1 per
unit of time to the recipient beginning at age t0 .
The present value (PV) at t0 of the payment if the
Rt r (tt )
recipeint lives to age t is t0 e r ( t0 ) d = 1e r 0 .
 (b) Calculate the expected cost to provide such
R r (tt ) F (t)
an annuity t0 1e r 0 1F (t0 ) dt. (In this case
the conditional distrbution of the remaining life is
independent of the age.)
(c) Find the distribution function for the case
h(t) = (1 t)1, 0 t 1. (Hint: F (t) is a
LDE as well as a separable variable DE.)
(d) Let = 2. Calculate the expected cost at t0
to provide the life annuity described above. if the
life annuity begins at age t0 :
R 1 1e r (tt0 ) F (t)
t0 r 1F (t0 ) dt.
2. In the war of attrition game, let the hazard rate of
F () 1
the distribution be 1F () = (1 ) , 0 1.
(a) Solve FOC to find the symmetric equilibrium.
(b) Is the 2nd order condition for player 1s
optimization problem satisfied?
3. Consider the dynamic n-firm oligopoly game:
market dynamics: p = a q1 . . . qn p
cost function: Ci (qi ) = 12 qi2
R
Profit function: i = 0 e rt [pqi C (qi )]
State variable: p Control variables: q1, ..., qn
(a) Find the DE of (p, m) for the symmetric
open-loop equilirium.
 (b) Solve the problem to find the path of p(t)
and q(t).
(c) Calculate the HJB equation of Vi (p) and the
FOC for a feedback equilibrium.
(d) Guess V = A bp + c2 p 2 in a symmetrical
equilibrium. Find b and c.
(e) Find the closed-loop strategy qi as a function
of p.
(f) Derive the DE for the equilibrium path of
p(t) and find the limit pf = limt p(t).
(h) Calculate limn pf and explain.
4. (HW 19.2) (Monopoly and cost reduction R&D)
Consider an infinitely lived monopoly. The profit at
moment t is given by [1 c(t)]2 where c(t) is unit
production cost at t. (e.g., it has a static demand
function given by q(t) = 4(1 p(t)).) The
monopoly is engaged in cost reduction R&D. At
each moment t, the expenditure on R&D is given
by 0.5c(t)2 . Let the discount rate be r . Given the
time path of the unit production cost c(t) 0,
0 t < , the present value of the monopoly
profit stream
Z is n o
rt 2 2
e [1 c(t)] 0.5c(t) dt.
0
Given c(0), an optimal solution is characterized by a
time T such that c(t) > 0 for t < T and c(t) = 0
for t T . The problem of the monopoly becomes
to find a T to maximize a fixed time calculus of
variation problem:
Z T n o
rt 2 2
max e [1 c(t)] 0.5c(t) dt+e rT /r .
T ,c(t) 0

A transversality condition states that at T ,

c(T ) = 0. (Of course, by definition, c(T ) = 0.)
 (a) Let r = 3. Derive the Euler equation for the
calculus of variation problem.
(b) Let c(0) = 0.25. Make use of the results of
problem 17.4 to solve the Euler equation to
obtain the cost path c(t), 0 t T .
(c) What can you say if c(0) = 1?
(d) Let r = 2. Given c(0) = 1, solve the
problem.
(e) Explain the difference between the results of
(b), (c), and (d).