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ECON 440/640 Problem Set 4 Answers

Problem 4.4
There are four possible pure-strategy equilibria in each problem: Pool on L Pool on R Type 1 plays L, type 2 plays R Type 1 plays R, type 2 plays L

a. Pool on L is not an equilibrium because type 2 want to play R (regardless of the receivers reaction). Pool on R is an equilibrium with (R) = 1/2 (L) [0, 1] a2 ( R ) = u a2 (L) = u or d. Type 1 playing L and type 2 playing R is an equilibrium, with (R) = Pr(t1 |a1 = R) = 0 (L) = Pr(t1 |a1 = L) = 1 a2 ( R ) = d a2 (L) = u. Type 1 playing R and type 2 playing L is not an equilibrium, because type 2s would play R instead instead. In part a, the key aspect of the problem setup seems to be that type 2s always prefer R to L.

b.

Pool on L is an equilibrium, with (R) = Pr(t1 |a1 = R) < 1/2 (L) = Pr(t1 |a1 = L) = 1/2 a2 ( R ) = u a2 (L) = u.

Pool on R is not an equilibrium becuse then a2 (R) = u and type 1s would like to deviate and play L. Type 1 playing L and type 2 playing R is an equilibrium, with (R) = Pr(t1 |a1 = R) = 0 (L) = Pr(t1 |a1 = L) = 1 a2 ( R ) = u a2 (L) = d. Type 1 playing R and type 2 playing L is an equilibrium, with (R) = Pr(t1 |a1 = R) = 1 (L) = Pr(t1 |a1 = L) = 0 a2 ( R ) = d a2 (L) = u.

Problem 4.8
There are two types of equilibria an uninformative equilibrium and a more informative equilibrium. An example of an uninformative equilibrium is m(t1 ) = m(t2 ) = m(t3 ) m, (t1 ) = (t2 ) = (t3 ) = 1/3 m, a = a2 Here is an example of an informative equilibrium: m(t1 ) = m(t2 ) = t2 m(t3 ) = t3 (t3 |m = t1 ) = 1 (t1 |m = t2 ) = (t2 |m = t2 ) = 1/2 (t3 |m = t2 ) = 0 (t3 |m = t3 ) = 1 a(m = t1 ) = a(m = t3 ) = a3 a(m = t2 ) = a2 2

The essential aspect of the equilibrium is that t1 and t2 are in one partition and t3 is in another.

Problem 4.9
In class we derived expressions for cut-points in the three-step equilibrium. For it to exist, 1 and 2 must both be between 0 and 1. The expression for 1 was 1 = 1 4b 3

so for 1 > 0 (in which case the three-step equilibrium exists), we require b < 1/12. It is pretty clear the receiver is better off on average in a three-step equilibrium than in a two-step equilibrium. One could integrate the equilibrium payoffs over [0, 1] or just graph them and argue geometrically. In a two-step equilibium, the cut-point is at 1/2 2b. The sender can get the receiver to 2 choose either a2 1 = 1/4 b or a2 = 3/4 b, so the utility of the sender is . max ( 1/4 + b)2 , ( 3/4 + b)2 .

In a three-step equilibrium, the sender can choose from three actions and so her utility is max ( 1/6 + 2b)2 , ( 1/2 + 2b)2 , ( 5/6 + 2b)2 .

The following gures depict the two cases.


us () 0
a2 1 a2 2

us ()
( 3/4 + b)2 ( 1/2 + 2b)2

a3 1

a3 2

a3 3

( 1/4 + b)2

( 5/6 + 2b)2

( 1/6 + 2b)2

2-Step

3-Step

The easiest way to gure out when the two-step equilibrium is better for particular probably starts by noting that the sender is better off if her type is closer to the equilibrium action 3

3 2 choice by the receiver. For between a2 1 and a1 , they will be closer to a1 if

1 1 b < + 2b 4 6 5 3b < 2 12 3b 5 > 24 2


3 2 and for between a2 1 and a2 , they will be closer to a1 if

1 1 2b > + b 2 4 3 3b > 2 4 3 3b < . 8 2 If 5 36b 3 12b << 24 8 then that sender would be better off in a two-step equilibrium. So for example, if b = 1/30, then for 0.158 < < 0.325, those senders would be better off in the two-step equilibrium. Similar calculations can be done for the second interval, around a2 2 , where senders would also be better off with the less informative equilibrium.

Problem 4.11
This problem illustrates the buyers curse, which has elements in common with the winners curse. Working backwards from the nal choice in the problem, the seller will accept the offer if Us (accept) Us (reject) p vs . Therefore the buyers expected utility when an offer of p is accepted Ub = k E[vs |accepted] p = p =k p= 2 k2 =p 2 4

To maximize this the seller will choose a p that is never accepted if k < 2 and a p that is always accepted if k > 2. The PBE is therefore p= as = 0 if k < 2 1 otherwise accept if p vs reject if p < vs

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