1. Firm 1 and firm 2 are automobile producers.

Each has the option of producing

either a big or a small car. The payoffs to each of the four possible combination of
choices are as given the following payoffs matrix. Each firm must make its choice
without knowing what the other has chosen.

Firm I

Big car
Small car
Big car II
1
= 400
II
1
= 800
II
2
= 400
II
2
= 1000
Firm 2
Small car II
1
= 1000
II
1
= 500
II
2
= 800
II
2
= 500
a. Does either firm have a dominant strategy?

A dominant strategy is the best response to the all strategies of all other players. In the
game above neither Firm 1 nor Firm 2 have a dominant strategy. In the table below the
underlined values are the choices that a _rm would make, given the other _rm has already
chosen the associated car size.



As can be seen in the table above, each firm would prefer to be producing the opposite
sized car as the other firm.

b. There are two Nash equilibrium for this game. Identify them.

In a two player game, a Nash Equilibrium is a strategy profile s1; s2 such that, for
each firm, s1* is a best response to the other player's equilibrium strategy s2*. Again,
looking at the underlined choices above, we can see that this game has two pure strategy
Nash Equilibria, namely Firm 1 chooses big car, Firm 2 chooses small car and Firm 1
chooses small car, Firm 2 chooses big car.

Additionally, since games almost always have an odd number of Nash Equilibria, we
should suspect that there is also a mixed strategy equilibrium. We can find this
equilibrium by calculating the the expected payoff for each firm. Let the strategies for
each firm be given by (B; 1-B) and (b; 1-b) for Firm 1 and Firm 2 respectively where B is
the probability that Firm 1 chooses big car and b is the probability that Firm 2 chooses
big car. Then the expected payoff for Firm 1 can be written as:

u
1
=B*b*400 + B(1- b)1000 + (1- B)(1- b)500 + (1- B)b*800
=500 + B*500 + b*300 B*b*900

And the expected payoff for Firm 2 can be written as

u
2
=B*b*400 + B*(1- b)*800 + (1-B)*(1-b)*500 + (1- B)*b*1000
=500 + B*300 + b*500 B*b*900

We can then use these results to _nd the mixed equilibrium. If the second _rm is playing
the mixed strategy (b; 1-b) then we can find the utility of Firm one building a big or small
car respectively as:

u
1
(big; (b; 1-b)) = 500 + 500 + b * 300 b*900
u
1
(small; (b; 1- b)) = 500 + b*300

For this strategy to be in equilibrium these two equations must be equal. We then find,
by solving for b that b = 5/9 . We now do the same for Firm 2.

u
2
((B; 1 - B); big) = 500 + B*300 + 500 b*900
u
2
((B; 1 - B); small) = 500 + B*300

Again, setting these equal, we find that B = 5/9 . Then, our mixed Nash Equilibrium is
that both firms build big cars with probability 5/9 . The following graph shows the three
mixed equilibria, two of which (E1 and E2) are the special cases of pure strategy
equilibria.




2. Suppose we have the same payoff matrix as in Problem 1 except now from firm 1
gets to move first and knows that firm 2 will see the results of this choice before
deciding which type of car to build.
a. Draw the game tree for this sequencial game.



b. What is the Nash equilirium for this game?

In the sequential game where Firm 1 gets to move first, Firm 1 will choose to produce
a big car. Firm 2 will then choose to produce a small car. The following diagram shows
this sequential game. The dashed line is the Nash Equilibrium. The bold line shows the
path Firm 2 would take if Firm one chose the (sub-optimal) path of producing a small car.












4. Two major networks are competing for viewer ratings in the 8:00 -9:00pm and
9:00-10:00pm slots on a given weeknight. Each has two shows to fill this time
period and is juggling its lineup. Each can choose to put its bigger show first or to
place it second in the 9:00-10:00pm slot. The combination of decisions leads to the
following rating points results:



Network 1
Network 2
First Second
First 20, 30 18, 18
Second 15, 15 30, 10

a. Find the Nash equilibria for this game, assuming that both networks make their
decisions at the same time.

A Nash equilibrium exists when neither party has an incentive to alter its strategy, taking
the others strategy as given. By inspecting each of the four combinations, we find that
(Second, First) is the only Nash equilibrium, yielding a payoff of (20, 30). There is no
incentive for either party to change from this outcome. If we pick First for Firm 1 and
Second for Firm 2, Firm 2 has an incentive to switch to First, in which case Firm 1 is
better switching to Second.

b. If each network is risk - averse and uses a maximin strategy, what will be the
resulting equilibrium?

This conservative strategy of minimizing the maximum loss focuses on limiting the
extent of the worst possible outcome, to the exclusion of possible good outcomes. If
Network 1 plays First, the worst payoff is 15. If Network 1 plays Second, the worst
payoff is 18. Under maximin, Network 1 plays Second. If Network 2 plays First, the
worst payoff is 15. If Network 2 plays Second, the worst payoff is 10. Under maximin,
Network 2 plays First (This is a dominant strategy). The maximin equilibrium is
(Second, First) with a payoff of (20,30).

c. What will be the equilibrium if Network 1 makes its selection first? If Network 2
goes first?

If Network 1 plays First, Network 2 will play First, yielding 15 for Network 1. If
Network 1 plays Second, Network 2 will play First, yielding 20 for Network 1.
Therefore, if it has the first move, Network 1 will play Second, and the resulting
equilibrium will be (Second, First). If Network 2 plays First, Network 1 will play
Second, yielding 30 for Network 2. If Network 2 plays Second, Network 1 will play
First, yielding 10 for Network 2. If it has the first move, Network 2 will play First, and
the equilibrium will again be (Second, First).

d. Suppose the network managers meet to coordinate schedules and Network 1
promises to schedule its big show first. Its is promise incredible? What would be the
likely outcome?
A move is credible if, once declared, there is no incentive to change. If Network 1 goes
first, then Network 2 will also want to go first which gives them both 15. In this case,
once Network 1 knows that Network 2 also wants to go first, Network 1 will wants to
change its strategy to Second. In this case, the promise to schedule the bigger show first
is not credible. Network 2 will schedule its bigger show First since this is a dominant
strategy and the coordinated outcome is likely to be (Second,First).