Game Theory. Master in Economics UB.

Problem Set 3
Deadline: Wednesday, June 4th, 2014
1. (Dollar auction) An object that two people each value at v = 2, a positive integer, is sold in
an auction. In the auction, the people take turns bidding; a bid must be a positive integer
greater than the previous bid. On her turn, a player may pass rather than bid, in which case
the game ends and the other player receives the object; Both player pay their last bids (if
any). Each persons wealth is w = 3; neither player can bid more than her bid. Model this
auction as an extensive game and nd the subgame-perfect equilibria.
2. (A rm-union bargaining) A rms output is L(100 L) when it uses L 50 units of labor,
and 2500 when it uses L > 50 units of labor. The price of output is 1. A union that represents
workers presents a wage demand (a non-negative number w), which the rm either accepts
or rejects. If the rm accepts the demand, it chooses the number L of workers to emply
(which you should take to be a continuous variable, not an integer); if it rejects the demand,
no production takes place (L = 0). The rms preferences are represented by its prot; the
unions preferences are represented by the value of wL.
(a) Find the subgame perfect equilbrium (or equilibria?) of the game.
(b) Is there an outcome of the game that both parties prefer to any subgame perfect equilib-
rium outcome?
(c) Find a Nash equilibrium for which the outcome diers from any subgame perfect equi-
librium outcome.
3. Suppose a parent and child play de following game, rst analyzed by Becker (1974). First
the child takes and action, A, that produces income for the child, I
C
(A), and income for the
parent, I
P
(A). (Think of I
C
(A) as the childs income net of any costs of the action A.) Second,
the parent observes the incomes I
C
and I
P
and then chooses a bequest, B, to leave to the
child. The childs payo is U(I
C
(A) + B); the parents is V (I
P
(A) B) + kU(I
C
(A) + B),
where k < 0 reects the parents concern for the childs well-being. Assume that: the action is
a non-negative number, A 0; the income functions I
C
(A) and I
P
(A) are strictly concave and
are maximized at A
C
> 0 and A
P
> 0, respectively; the bequest B can be positive or negative;
and the utility functions U and V are increasing and strictly concave. Prove the Rotten Kid
Theorem: in the backwards-induction outcome, the child chooses the action that maximizes
the familys aggregate income, I
C
(A) + I
P
(A), even though only the parents payo exhibits
altruism.
4. Three oligopolists operate in a market with inverse demand given by P(Q) = a Q, where
Q = q
1
+q
2
+q
3
and q
i
is the quantity produced by rm i. Each rm has a constant marginal
cost of production, c, and no xed costs. The rms choose their quantities as follows: (1)
rm 1 chooses q
1
0; (2) rms 2 and 3 observe q
1
and simultaneously choose q
2
and q
3
,
respectively. What is the subgame-perfect outcome?
5. Consider the following strategies in the innite-horizon version of Rubinsteins bargaining
model. (Recall the notational convention that the oer (s, 1 s) means that Player 1 will get
s and Player 2 will get 1 s, independent of who made the oer.) Let s

= 1/(1 +). Player

1 always oers (s

, 1 s

) and accepts an oer (s, 1 s) only if s s

. Player 2 always oers

(1 s

, s

) and accepts an oer (s, 1 s) only if 1 s s

. Show that these strategies are a

Nash equilibrium. Show that this equilibrium is subgame-perfect.
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6. Suppose the players in the Rubinsteins innite-horizon bargaining game have dierent dis-
count factors:
1
for player 1 and
2
for player 2. Adapt the argument in class to show that
in the backwards-induction outcome, player 1 oers the settlement

1
2
1
1

2
,

2
(1
1
)
1
1

to player 2, who accepts.

7. The accompanying simultaneous-move game is played twice, with the outcome of the rst stage
observed before the second stage begins. There is no discounting. The variable x is greater
than 4, so that (4, 4) is not an equilibrium payo in the one-shot game. For what values of x
is the following strategy (played by both players) a subgame-perfect Nash equilibrium?
Play Q
i
in the rst stage. If the rst stage outcome is (Q
1
, Q
2
), play P
i
in the second stage. If
the rst-stage outcome is (y, Q
2
) where y = Q
1
, play R
i
in the second stage. If the rst-stage
outcome is (Q
1
, z) where z = Q
2
, play S
i
in the second stage. If the rst-stage outcome is
(y, z) where y = Q
1
and z = Q
2
, play P
i
in the second stage.
P
2
Q
2
R
2
S
2
P
1
2, 2 x, 0 -1, 0 0, 0
Q
1
0, x 4, 4 -1, 0 0, 0
R
1
0, 0 0, 0 0, 2 0, 0
S
1
0, -1 0, -1 -1, -1 2, 0
8. The simultaneous-move game (below) is played twice, with the outcome of the rst stage
observed before the second stage begins. There is no discounting. Can the payo (4, 4) be
achieved in the rst-stage in a pure-strategy subgame-perfect Nash equilibrium? If so, give
the strategies that do so. If not, prove why not.
L C R
T 3, 1 0, 0 5, 0
M 2, 1 1, 2 3, 1
B 1, 2 0, 1 4, 4
9. Recall the static Bertrand duopoly model (with homogeneous goods): the rms name prices
simultaneously; demand for rm is product is a p
i
if p
i
< p
j
, is 0 if p
i
> p
j
and is (a p
i
)/2
if p
i
= p
j
; marginal costs are c < a. Consider the innitely repeated game based on this stage
game. Show that the rms can use trigger strategies (that switch forever to the stage-game
Nash equilibrium after any deviation) to sustain the monopoly price level in a subgame-perfect
Nash equilibrium if and only if 1/2.
10. Suppose there are n rms in a Cournot oligopoly. Inverse demand is given by P(Q) = a Q,
where Q = q
1
+ +q
n
. Consider the innitely repeated game based on this stage game. What
is the lowest value of such that the rms can use trigger strategies to sustain the monopoly
output level in a subgame-perfect Nash equilibrium? How does the answer vary with n, and
why? If is too small for the rms to use trigger strategies to sustain the monopoly output,
what is the most protable symmetric subgame-perfect Nash equilibrium that can be sutained
using trigger strategies?
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