Tarun Singh

Economics 1030 Problem Set #6

Problem 1:

a) EB(q|m= H, s=D)= EB(q|m=NH, s=D)=1

b) EB(q|s= F)< EB(q|m= H, s=F) because knowing that the female chimp has an
hour glass figure guarantees that they will have an E B=2, whereas if no
information is known regarding the figure of the female chimp and there is a
non-zero possibility that a female chimp may have an NH figure the EB<2.
Similarly EB(q|m=NH, s= F)< EB(q| s=F) because knowing that that the female
chimp does not have an hourglass figure ensures that EB=0, whereas if no
information is known regarding the figure of the female chimp and there is a
non-zero possibility that a female chimp may have an H figure the EB>0. It is
different to observe m=H when s=D compared with s=F because when s=D
the information regarding the shape doesn’t change EB since EB(q|m= H,
s=D)= EB(q|m=NH, s=D)=1, but when m=D the shape actually changes EB.

c) EC(q|m= H, s=D)= EB(q|m= H, s= s*)p(s= s*)+ EB(q|m= H, s≠s*)p(s≠s*)

p(s=s*)=.5 → p(s≠ s*)=.5
→ EC(q|m= H, s=D)= EB(q|m= H, s= s*).5 + EB(q|m= H, s≠s*).5
Let s*=D
→ EC(q|m= H, s=D)= EB(q|m= H, s=D).5 + EB(q|m= H, s≠D).5
= EC(q|m= H, s=D)= (1).5 + (2).5 = 1.5
EC(q|m= NH, s=D)= EB(q|m= NH, s=D).5 + EB(q|m= NH, s≠D).5
= EC(q|m= NH, s=D)= (1).5 + (0).5 = .5
EC(q|m= H, s=D)> EC(q|m= NH, s=D)
The chimp is overreacting because by using coarse thinking he is changing is
expected utility based on whether or not the drink has an hourglass shape or
not even though the shape of the drink reveals no additional information
about the utility of the drink. Instead the coarse thinking model changes the
expected utility based on information that isn’t relevant to the drink when
thinking using a Bayesian method.

d) If the chimps are Bayesian thinkers then they do not value the drink
differently based on the shape of the bottle and thus the manufacturer would
be willing to pay C=0 to use a contour bottle.
If chimps think coarsely:
The normal bottle has an expected profit of:
Willingness to pay-cost of bottle=.5-0=.5
The contour bottle has an expected profit of:
Willingness to pay-cost of bottle=1.5-C*=.5
 →C*=1
The company would be willing to pay a maximum of C*=1 to use a contour
bottle

e) EC(q|m= H, s=D)= EB(q|m= H, s=D).5 + EB(q|m= H, s≠D).5

= EC(q|m= H, s=D)= (1).5 + (1).5 = 1.5
EC(q|m= NH, s=D)= EB(q|m= NH, s=D).5 + EB(q|m= NH, s≠D).5
= EC(q|m= NH, s=D)= (1).5 + (0).5 = .5
The normal bottle has an expected profit of:
Willingness to pay-cost of bottle=.5-0=.5
The contour bottle has an expected profit of:
Willingness to pay-cost of bottle=1-C*=.5
→C*=.5
Since the new information only changes the value of the hourglass females
the normal bottle profit does not change but the profit for the hourglass
bottle decreases by .5. So in order to value C* we must keep profit constant
between the two types of bottles and thus C* must also decrease by .5

f) Soldiers are sex-deprived and therefore assign more weight to the hourglass
figure in their coarse thinking model. Thus this amplifies the effect of the
hourglass figure on the utility of the drink compared with the parts above.
This is seen below:
EC(q|m= H, s=D)= EB(q|m= H, s=D).25 + EB(q|m= H, s≠D).75
= EC(q|m= H, s=D)= (1).25 + (2).75 = 1.75
EC(q|m= NH, s=D)= EB(q|m= NH, s=D).25 + EB(q|m= NH, s≠D).75
= EC(q|m= NH, s=D)= (1).25 + (0).75 = .25
The normal bottle has an expected profit of:
Willingness to pay-cost of bottle=.25-0=.25
The contour bottle has an expected profit of:
Willingness to pay-cost of bottle=1.75-C*=1.5
→C*=1.5

Problem 2

a) i) σ=ρ =0
→ UA(xA ,xB)= xA if xA>xB
= xA if xA<xB
= xA if xA=xB

Player A has the same utility payoff regardless of how his payoffs compare to
those of Player B.

ii) 0<σ<ρ

→ UA(xA ,xB)= xA – σ(xA -xB) if xA>xB

= xA – ρ(xB –xA) if xA<xB
 = xA if xA=xB

Player A is impacted by his payoff relative to the payoff of Player B. Player A’s
utility is negatively impacted if there is a difference between his payoff and
Player B’s payoff, but is less impacted when his payoffs are larger than those
of Player B. Thus Player A values equality but values it less when his payoffs
are higher than Player B’s payoffs.

iii) σ<0<ρ

→ UA(xA ,xB)= xA + σ(xA -xB) if xA>xB

= xA – ρ(xB –xA) if xA<xB
= xA if xA=xB

Player A’s utility is negatively impacted if his payoff is lower than the payoff
of Player B and his Player A’s utility is positively impacted if his payoff is
higher than the payoff of Player B. This makes the variance of Player A’s
utility higher as a payoff higher than the payoff of Player B magnifies Player
A’s utility and a payoff lower than the payoff of Player B shrinks his utility.

iv) 0<σ=ρ

→ UA(xA ,xB)= xA – ρ(xA -xB) if xA>xB

= xA – ρ(xB –xA) if xA<xB
= xA if xA=xB
Player A’s utility is equally negatively impacted if his payoffs are either higher
or lower than those of Player B. This means Player A is equally averse to
inequality in any direction.

b) if xA>xB:
UA(xA ,xB)= xA – σ(xA -xB)
→(∂/∂xA) UA(xA ,xB)= 1-σ
→(∂/∂xB) UA(xA ,xB)= σ
if xA<xB:
UA(xA ,xB)= xA – ρ(xB –xA)
→(∂/∂xA) UA(xA ,xB)= 1+ρ
→(∂/∂xB) UA(xA ,xB)= -ρ

c) if xA>xB:
UA(xA ,xB)=xA-σ(2xA-10)
→(d/dxA) UA(xA ,xB)= 1-2σ =[(∂/∂xA) UA(xA ,xB)]-[(∂/∂xB) UA(xA ,xB)]=1-σ-σ
if xA<xB:
UA(xA ,xB)=xA-ρ(10-2xA)
→(d/dxA) UA(xA ,xB)= 1+2ρ =[(∂/∂xA) UA(xA ,xB)]-[(∂/∂xB) UA(xA ,xB)]=1+ρ-(-ρ)

d) i) UA(xA ,xB)= xA if xA>xB

 = xA if xA<xB
= xA if xA=xB
Optimal bid = xA=10 since Player A’s utility is only based on his payoffs

ii) UA(xA ,xB)= xA – σ(xA -xB) if xA>xB

= xA – ρ(xB –xA) if xA<xB
= xA if xA=xB
(d/dxA) UA(xA ,xB)= 1-(6/5)= -.2 if xA>xB
= 1+(12/5)=3.4 if xA<xB
=1 if xA=xB

The optimal bid is where the marginal utility is positive and xA is greatest
since bidding at this point is where he extracts all possible utility.

This point is when marginal utility =1 or when xA=xB , meaning his optimal
bid is xA=xB=5.

iii) UA(xA ,xB)= xA + σ(xA -xB) if xA>xB

= xA – ρ(xB –xA) if xA<xB
= xA if xA=xB
(d/dxA) UA(xA ,xB)= 1+2σ if xA>xB
= 1+2p if xA<xB
=1 if xA=xB

Since the marginal utility is always positive, Player A’s utility is always
increasing with higher payoffs, thus he should bid xA=10 in order to maximize
his utility.

iv) UA(xA ,xB)= xA – ρ(xA -xB) if xA>xB

= xA – ρ(xB –xA) if xA<xB
= xA if xA=xB
(d/dxA) UA(xA ,xB)= 1-2(3/4)=-.5 if xA>xB
= 1+2(3/4)=2.5 if xA<xB
=1 if xA=xB

The optimal bid is where the marginal utility is positive and xA is greatest
since bidding at this point is where he extracts all possible utility.

This point is when marginal utility =1 or when xA=xB , meaning his optimal
bid is xA=xB=5.

Problem 3

a) If both Player A and Player B contribute, both will have payoffs of 2M meaning
xA=xB , so Player A has a utility of 2M. If Player A does not contribute then her
payoffs are 1+M and Player B’s payoffs are just M. This makes Player A’s
utility 1/3 +M.
 →Player A is willing to contribute if M≥1/3. If M≥1/3 then there is a Nash
equilibrium if both players are contributing as both players have an incentive
to contribute if the other is player is doing so.

b) Assuming Player B does not contribute and Player A does, Player A’s payoffs
are M and Player B’s payoffs are 1+M. This would make Player A’s utility M-
4/3. On the other hand, if Player A does not contribute either, both players
have payoffs of 1 and Player A’s utility is 1.
→Player A is not willing to contribute if M≤7/3. If M≤7/3 then there is a Nash
equilibrium if both players are not contributing as bother players have no
incentive to contribute if the other player is not doing so.

c) When 1/3≤M≤7/3 there is an equilibrium when both players contribute and

an equilibrium where both players do not contribute.

d) If Player A’s utility function = xA then Player A will not contribute if M<1 – this
gives Player A a higher utility regardless of Player B’s actions.

e) When M=2/3 we know that Player B will choose to do the same thing Player A
does. If both players contribute, both get payoffs of 4/3 and if both do not
contribute both get payoffs of 1 – thus it is optimal for Player to contribute in
order to maximize utility.