212.

339 Game theory and Appications 2003

In Ho Lee

Mid-Term Examination
October 20, 2003

1. (10 points) Carefully define Nash equilibrium and subgame perfect equilibrium.

2. (10 points) What is the meaning of rationality in game theory? Explain its role in game
theory.

3. (25 points) Find a game which is not solvable by pure strategy iterated strict dominance
but which does have a unique pure strategy Nash equilibrium.

4. (25 points) Consider a game in which two students simultaneously choose effort levels
e1 , e2 [0, 1] in studying for an exam. The exam is graded on a curve and effort directly
determines performance, so the student who works harder will get an A and the other
student will get a B. If the students exert identical effort assume that they both get Bs.
Assume that each student receives one extra util from getting an A instead of a B and a
disutility of 2e2 utils from expending effort e. First prove that there is no pure strategy
Nash equilibrium. Next find a mixed strategy Nash equilibrium of this game.

5. (30 points) Suppose that two players play each other for two periods. In the first period
they play the first game below, and in the second period they play the second game below.
There is no discounting between periods. Players observe the action their opponent took
in the first period before choosing their second period actions.

L R
U 2, 2 -10, x
D y, 0 0, 0

L R
U 8, 4 0, 0
D 0, 0 4, 8

1
(a) For x 2 and y 6, find a subgame perfect equilibrium in which player 1 receives
a payoff of 10.

(b) For x = 5 and y = 3, find a subgame perfect equilibrium in which player 2 receives
a payoff of 10.

(c) For x = y = 4 show that there is no subgame perfect equilibrium in which (U, L) is
played in the first period.

2
212.339 Game theory and Applications 2004
In Ho Lee

Mid-Term Examination
October 25, 2003

1. A group of n students go to a restaurant. It is common knowledge that each student will

simultaneously choose his own meal, but all students will share the total bill equally. If
a student gets a meal of price p and contributes x towards paying the bill, his payoff will

be p x. The student can choose a meal whose price is any real number.

(a) Compute the Nash equilibrium for n = 1 and n = 2.

(b) Deduce the Nash equilibrium for an arbitrary n. What happens as n ?

2. This question is about a milkman and a customer. At any day, milkman puts m [0, 1]
liter of milk and 1 m liter of water in a container and closes the container, incurring
cost 21 m. Customer, without knowing m, decides on whether or not to buy the liquid at
some price p. If she buys, her payoff is m p and the milkmans payoff is p 12 m. If she
does not buy, she gets 0, and the milkman gets 21 m. If she buys, then she learns m.

(a) Find the subgame-prefect equilibrium when the game is played once.

(b) Assume that this is repeated for 100 days, and each player tries to maximize the sum
of his or her stage payoffs. Find a subgame-perfect equilibrium of this game.

(c) Now assume that this is repeated infinitely many times and each player tries to
maximize the discounted sum of his or her stage payoffs, where discount rate is
(0, 1). What is the range of prices p for which there exists a subgame perfect
equilibrium such that, everyday, the milkman chooses m = 1, and the customer
buys on the path of equilibrium play?

3. Consider two agents {1, 2} owning one dollar which they can use only after they divide
it. Each players utility of getting x dollar at t is t x for (0, 1). Given any n > 0,
consider the following n-period symmetric, random bargaining model. Given any date
t = {0, 1, . . . , n 1}, we toss a fair coin; if it comes Head (which comes with probability

1
1/2), we select player 1; if it comes Tail, we select player 2. The selected player makes an
offer (x, y) [0, 1]2 such that x+y 1. Knowing what has been offered, the other player
accepts or rejects the offer. If the offer (x, y) is accepted, the game ends, yielding payoff
vector ( t x, t y). If the offer is rejected, we proceed to the next date, when the same
procedure is repeated, except for t = n 1, after which the game ends, yielding (0, 0).
The coin tosses at different dates are stochastically independent. Each player accepts the
offer when accepting it and rejecting it yield the same utility. And everything described
up to here is common knowledge.

(a) Compute the subgame perfect equilibrium for n = 1. What is the value of playing
this game for a player? (That is, compute the expected utility of each player before
the coin-toss, given that they will play the subgame-perfect equilibrium.)

(b) Compute the subgame perfect equilibrium for n = 2. Compute the expected utility
of each player before the first coin-toss, given that they will play the subgame-
perfect equilibrium.

(c) What is the subgame perfect equilibrium for n 3?

2
212.339 Game theory and Applications 2005
In Ho Lee

Mid-Term Examination
October 26, 2005

1. (a) Carefully define common knowledge.

(b) Explain the critique of subgame perfect equilibrium using the centipede game.

(c) Suppose that the rationality of the players is not common knowledge in the cen-
tipede game. If the first player plays the strategy which allows the second player
to make further choice, can you explain how to reconcile the first players strategy
choice?

2. Consumers consider whether to purchase a PC. A PC lasts two periods at most. A con-
sumer gets the utility u() = v where is a preference parameter unique to the consumer
and v is the quality of the PC common to all consumers who use it. Consumers prefer-
ence parameter is distributed uniformly on [0, 2]. The PC is produced by a monopolist
at the constant marginal cost of 0. Consumers and the monopolist discounts the future at
the common discounting factor .

(a) Suppose that the monopolist is renting the PC to the consumers at the price of p
each period for period 1 and 2. Hence a consumer who rents it gets the utility v p
each period after paying the rental fee. Determine the condition for a consumer to
rent it. Derive the rental demand function for the PC.

(b) Solve for the profit maximizing rental price for the monopolist when the monopolist
rents the PCs each period for two periods. Compute the total discounted profit.

(c) Suppose that the monopolist considers selling the PCs. The PC lasts two periods
if purchased in the first period, while it lasts one period if purchased in the second
period. Hence the consumer gets the total utility of (1 + )v if he buys it in the
first period and v if he buys it in the second period. Determine the condition for
the consumer to purchase it in the second period at the price of p2 . Assuming that
all consumers whose valuation parameter is higher than 1 has purchased the PC in
the first period, derive the demand function for the PC in the second period when
the price is set as p2 .

1
 (d) Determine the condition for the consumer to purchase it in the first period given the
first period price p1 and the second period price p2 . Derive the demand function for
the PC in the first period.

(e) Solve for the profit maximizing price sequence (p1 , p2 ) for the monopolist. Compute
the discounted profit of the monopolist and compare it with the rental profit. Explain
why it is smaller than the rental profit.

3. Consider the following game .

b1 b2 b3
a1 10, 10 2, 12 0, 13
a2 12, 2 5, 5 0, 0
a3 13, 0 0, 0 1, 1

(a) Compute all the Nash equilibrium in pure strategy and mixed strategy of when
played once.

(b) Suppose that the game is played twice by the same players. The players do not
discount the future, that is, = 1. Characterize a subgame perfect equilibrium in
which (a1 , b1 ) is played in the first period. Justify your answer.

(c) Instead of playing the game twice automatically, player 1 rolls a die after the first
play and the players play it again if the outcome is if the outcome is one of {1, 2, 3, 4, 5};
otherwise the game ends in the first round. Is there a subgame perfect equilibrium
in which the players play (a1 , b1 ) in the first round?

(d) Does your answer change if the players play it for the second time if the outcome
of rolling the die is an even number? Explain.

2
212.339 Game theory and Applications 2006
In Ho Lee

Mid-Term Examination
October 24, 2006

1. Two communities, A and B are located on the shore of the same lake. Each year, each
community decides, how much to invest in pollution reduction. The reduction levels
are xA and xB : xA and xB are determined in a simultaneous move game. The utility
from reduction (and thus better water quality) is given by: uA (xA ; xB ) = uB (xA ; xB ) =
(xA + xB ): The cost of reduction is given by: cA (xA ) = x2A ; cB (xB ) = x2B : Payos are
utilities net of cost, i.e. A = uA cA and B = uB cB :

(a) Find the Nash equilibrium of the one shot game.

(b) Dene Pareto optimality. Is the Nash equilibrium Pareto optimal? To answer
this, maximize
uA (xA ; xB ) + uB (xA ; xB ) cA (xA ) cB (xB )
by choosing xA and xB : What is the reason for this ine ciency?

2. Consider the following case of a dierentiated good Cournot model. Firm i produces
type i widgets at a constant unit cost of ci ; i = 1; 2. If q1 and q2 are the quantities of
the two varieties produced, the respective prices for the two goods are determined by
the demand equations p1 = M 2q1 q2 and p2 = M q1 2q2 .

(a) Adapt Cournots duopoly model to this new situation, and nd the rmsreaction
functions
(b) Find the quantities produced in equilibrium and prices at which the goods are
sold and the equilibrium prots.

3. Suppose three rms compete in a market for a single product with industry inverse
demand curve p = A q: All three rms have constant marginal cost c. Firm 1 is a
leader and selects output level q1 : Firms 2 and 3 are followers and select q2 and q3 after
q1 : (Note, q2 and q3 are chosen simultaneously.) Total output is q = q1 + q2 + q3 . Find
a subgame perfect equilibrium solution.
4. Five ferocious pirates are dividing their plunder of 100 gold coins according to the
following rules: pirate #1 suggests a way of sharing the coins (no single coin can be
sub-divided): for example he might suggest (80, 5, 5, 5, 5), meaning that he gets 80
coins and the others get 5 each. All ve pirates vote (by roll call) on the proposal.
If a majority accepts, the division is carried out. Otherwise the rst pirate is thrown
overboard and pirate # 2 makes a proposal, which is subjected to majority vote and
so on. Ties are broken in favor of the proposer. Consider the path of subgame perfect
equilibrium in which any voter who is indierent between accepting or rejecting an
oer votes to reject.

1
(a) Suppose that there are only two pirates remaining, #4 and #5. Solve for the
subgame perfect equilirium for this subgame.
(b) Suppose that there are only three pirates remaining, # 3, #4 and #5. Solve for
the subgame perfect equilirium for this subgame.
(c) Solve for the subgame perfect equilibrium for the original game with 5 pirates.

2
 212.339 Game theory and Applications 2008 Autumn
In Ho Lee

Midtern1 EXan1
(October 28
2008)

1. Two drivers player 1 and player 2 are simultaneously approaching an intersction

from different directions. They may choose to stop (S) or continu (C) at the
intersection. If they both stop they prevent a crash and ach receives a payoff of 1.
If they both continue they crash and each receives a payoff of O. If only player 2
stops then player 1 gets a payoff of 2 whereas player 2 gets a payoff of 1 - c
where c reflects the dislike of the player being the only one to stop. Conversely if
only player 1 stops then she gets 1 - c and player 2 gets 2. Assume 0 < c < 1.

a. FOl111Ulate this situation as a strategic form game.

b. Find all the Nash equilibria (i n pure and mixed strategies). Find the expected
payoff of each player at the mixed strategy equilibrium.
c. Now suppose that the drivers are educated so that they feel guilty about
choosing to continue i.e.
about being aggressive. In particular
suppose that the
payoff of a player from choosing C decreases by g where 0 < g < 1
irrespective of what the other driver does. Find the mixed strategy equilibrium
and show that both players are better off in this equilibrium than they are in the
mixed strategy equilibrium in part (b).

2. Anny A has a single plane with which it can strike one of three possible targets.
Anny B has on anti-aircraft gun that can be assigned to one of the targets. The
value of targt k is V kwith VI > V2 > V3 > O. Anny A can destroy a target only if
the target is undefended and A attacks it.Army A wishes to maximize the expected
value of the damage and anny B wishes to minimize it. Fonnulate the situation as a
strategic fonn game and find Nash equilibria.

3. Consumers consider whether to purchase a PC. A PC lasts two periods at most. A

consumer gets the utility u(e) = ev ;vhere e is a preference parameter unique to the
consumer and V is the quality bf the PC common to all consumrs who use it.
Consumer s preference parameter e is distributd uniformly on [0 2]. The PC is
produced by a monopolist at the constant marginal cost of O. Consumers and the
monopolist discounts th future at the common discounting factor o.

a. Suppose that the monopolist is renting the PC to the consumers at the price of p
each period for period 1 and 2. In other words the monopolist rents the PC for
each period and consumers have to rent it from the monopolist again each
period. Hence a consumer who rents it gets the utility ev - peach priod after
paying the rental fee. Determine the condition for a consumer to rent it. Derive
the rental demand function for the PC.
b. Solve for the profit maximizing rental price for the monopolist when the

1
 monopolist rents the PCs each period for two periods. Compute the total
discounted profi t.
c. Suppose that the monopolist considrs selling the PCs. The PC lasts two periods
if purchased in th first priod while it lasts one period if purchased in the
second period. Hence the consumer gets the total utility of (1 + o )e v if he buys
it in the first priod and ev if he buys it in the second period. Determine the
condition for the consumr to purchase it in the second period at the price of
P2. Assuming that all consumers whose valuation parametr is higher than J e
has purchased the PC in the first period derive the dmand function for the PC
in the second period when the price is set as P2.
d. Determine the condition for the consumer to purchase it in the first period given
the first period price p I and the second period price P2. Derive the demand
function for the PC in the first period.
e. Solve for the profit maximizing price squence (P I
P2) for the monopolis t.
Compute the discounted profit of the monopolist and compare it with the rental
profi t.Explain why it is smaller than the rental profi t.

4. Consider the following mode l. The inverse demand function is P(x) = 10 - x

where P = price and x = total aut. There are two firms producing a
homogeneous good. At the first stage firm l(incumben t) chooses kJ which is an
irrevocable commitment of investment which alters the initial conditions of the
post-entry game to make some advantages to itsel f. At the second stage firm 2
decides to enter the market(E) or to stay out( S) dpending on its expected
If the firm 2entrs the market
post-entry profi t. they will compte a la Courno t.
Otherwise the incumbent will prvail as a monopoly. The firm 1 and firn1 2 s cost

functionsareCJ
I wXJ
= ~ .. --
+ rkJ
.._
XI kJ
-- -:;.. andC2 =f+(w+r)x2respectively
I (w + r)xJ XI < kJ

where f is the fixed cost for the entrant

w is the constant average variable cost for
and r is the constant cost per unit of capacity. Assume that f = 17116
output
w - 0 r = 4.

a. For an arbitrary kl draw the each firm s reaction curve in the second period on
X J - X2 plane. And find the credible interval of kl i.e.
the intrval of ki which
can induce the Nash equilibrium in th second period. (Note that th firm 1 s
reaction curve will b kinked.)
b. In the interval of kJ you get above find th critical valu of kl which change
firm 2 s entl decision.
c. Knowing all the facts you get above what is th optimal kJ for the firm I?
Describe the SPE of this game fully.
d. Based on this case do you think that the irrevocable commitment of investment
might be used as a tool of deterring the entrant by the incumbent?