Econ 6036 Spring 2012

Problem Set 2
The due date for this problem set is May 2. You should either email me your
problem set or hand it in to my mailbox in the General Oce at 9F KKL. The
problem set is to help you study the material we have covered. It will be graded
very roughly and mainly on your eorts.
1. Consider an auction of one single object with 3 bidders. The object is worth $
i
to
bidder i, for i = 1. 2. 3. Given any i = 1. 2. 3, bidder is valuation of the object,
i
,
is known only to herself, not to anyone else. Each
i
is independently and uniformly
distributed on the unit interval [0. 1]. If bidder i pays a price j
i
and obtains the object,
her utility is
i
j
i
, while if she pays j
i
without obtaining the object, her utility is
j
i
. All of the above is common knowledge.
Consider a simultaneous sealed-bid all-pay auction with reserve price /
0
as follows. All
bidders submit a nonnegative bid simultaneously. The highest bidder among those
who bid at or above /
0
2 [0. 1] wins the object. If : bidders submit the highest bid at
or above /
0
, then the object is assigned to each of the highest bidder with probability
1
m
. Each bidder pays her own bid whether or not she wins the object.
(a) What is the type space for bidder i?
(b) Suppose bidder 1s valuation of the object is
i
, what is her belief about the
probability distribution of (
2
.
3
)?
(c) Consider /
0
= 0. Let ,

be the bidding strategy where ,

() =
2
3

3
.
1. If every bidder other than bidder i uses ,

, what is the probability that bidder

i wins the object if she submits bid /
i
?
2. If bidder is valuation is
i
, given that the other two bidders both use bidding
strategy ,

, what is her expected payo from submitting bid /

i
?
3. Show that it is a Bayesian Nash equilibrium for every bidder to use ,

.
4. In the symmetric BNE where each bidder uses ,

, what is the auctioneers

expected revenue?
(d) Consider /
0
= 0. Let , be a strictly increasing function from [0. 1].
1. If all bidders other than bidder i use strategy ,, and if bidder is valuation is

i
, what is bidder is expected payo from submitting bid /
i
?
2. Show that the unique symmetric Baysian Nash equilibrium in this game in
strictly increasing bidding functions is for each bidder to use ,

.
(e) (Dont need to hand in this one. It is designed to help you understand the part
on optimal reservation price) Consider /
0
0. Consider a bidding strategy
^
, ()
such that , () = 0 for all <

and , is strictly increasing and dierentiable

from [

. 1] to [/
0
. 1]. Suppose every bidder other i follow
^
,.
1. Suppose bidder i submits bid /
i
= /
0
. What is the probability that she wins?
2. What is bidder is payo if she submits /
i
= /
0
and her valuation is
i
?
1
3. What is the necessary and sucient condition for

to be the lowest type of

bidder i that weakly prefers to participate? Assume that

is equal to the
expression you found.
4. What is bidder is expected payo if her valuation is
i
and if she submits
bid
^
, (
0
i
)?
5. Suppose
i

. What is the necessary and sucient condition for i to prefer

submitting bid
^
, (
i
) to submitting bid
^
, (
0
i
) for all
0
i
2 [0. 1]?
6. Dene l (
i
) to be bidder is expected payo if her valuation is
i
and everyone
uses
^
,. Suppose
^
, is bidder is best response given that everyone else follows
^
,. What is l
0
(
i
)? (Hint: if is valuation is
i
+o instead of
i
, then i will bid
slightly higher and win with slightly higher probability if i follows
^
,. What
is the eect of bidding
^
, (
i
+ o) instead of
^
, (
i
) as o ! 0? Use the answer
for the previous subquestion) You can interpret this as the extra payo type

i
+o needs to get in equilibrium for her to be willing to bid
^
, (
i
+ o) instead
of
^
, (
i
).
7. Find the unique symmetric Bayesian Nash equilibrium in which bidders with
valuation above a cuto use a strictly increasing bidding strategy.
8. Consider this symmetric BNE you found. What is the expected amount
bidder i with valuation
i
pay to the auctioneer in equilibrium? You can
derive it directly from
^
,. You can also derive it indirectly from the relation
between
^
, (
i
) and l (
i
) and use the expression for l
0
(
i
) you found. Note
that these two methods give you the same expression. Note that bidder
is expected payment to the auctioneer is less than her valuation times her
expected probability of winning. The dierence is exactly
R
v
i
v
l
0
(r) dr, which
is bidder is rent (i.e. equilibrium payo) when her type is
i
.
9. What is the auctioneers expected revenue in equilibrium?
10. Assuming the object has no value to the auctioneer. Therefore the auction-
eers payo is her expected revenue. What is the optimal reserve price /
0
for
the auctioneer?
2. Work out the double auction model in Gibbons 3.2C. Do not hand it in.
3. Work out the job market signaling model in Gibbons 4.2B. Do not hand it in.
4. Gibbons 4.14.
5. Consider the currency attack problem. There is a continuum of traders i 2 [0. 1]. If a
trader attacks, his payo is o if attack is successful and o 1 if attack is unsuccessful.
If a trader does not attack, his payo is 0. The attack is successful if and only at
least
2
3
of the traders attack. No trader knows o. Every trader i observes a noisy
signal r
i
= o +
i
where
i
` (0. o
2
) and each
i
are independently distributed.
Everyone shares an improper prior that o is uniformally distributed on the real line.
For all answers, let (.) denote the cumulative distribution function for standard
normal distribution. Therefore, the probability that is lower than c is

if
is normal distributed with mean o and variance o
2
.
(a) What is the set of pure strategies for a player in this game?
2
(b) Conditional on player is signal r
i
, what is the distribution of o?
(c) Suppose everyone uses a switching strategy
:
k
=

ttcc/ if r
i
/
`otttcc/ if r
i
< /
.
1. Given o, what is proportion of traders who attack?
2. What is the condition on o for less than
2
3
of the traders to attack?
3. What is trader is payo from attacking if the underlying state is o?
4. Conditional on trader is signal r
i
, what is the probability that less than
2
3
of
the traders will attack?
5. What is is expected payo from attacking given his signal r
i
?
6. What is the necessary and sucient condition on r
i
so that trader i weakly
prefers to attack if his signal is r
i
?
7. What is the necessary condition for trader 1 with signal / to be indierent
between attacking and not attacking?
(d) What is the necessary and sucient condition on / for it to be a PBE that both
traders use switching strategy :
k
?
(e) If trader 1 believes that the probability that trader 2 invests is uniformly distrib-
uted on [0. 1], what is his best response?
6. Consider the game between a restaurant owner and a customer as in the table. The
customer can choose to order an expensive dish or a cheap dish. If the customer orders
a cheap dish, both get payo 0. If the customer orders an expensive dish, the owner
then decide whether to put in eorts. If the owner puts in eorts and produce high
quality food, the dish will come out great and both get payo 1. If the owner shirks
and produces low quality food, the customer gets 2 and the owner gets 2.
(a) Find the unique backward induction solution.
(b) Suppose with probability j, the owner may be a passionate chef who never pro-
duces low quality food, and with probability 1 j, the owner is the normal type
as previously described. Find a perfect Baysian equilibria. Discuss if it changes
with j.
(c) Suppose the restaurant operates for 2 periods. A new customer comes in each
period. The second customer observes the past histor, i.e. the rst customers
order and experience.
1. Find a PBE.
2. What is the smallest value of j such that the rst customer will order the
expensive dish with positive probability?
(d) Suppose the restaurant operates for 3 periods.
1. Find a PBE.
2. What is the smallest value of j such that the rst customer will order the
expensive dish with positive probability?
3
7. Consider the Sender-Receiver game in Crawford and Sobel (1982) where the Senders
type t is uniformly distributed on [0. 1]. Receivers payo if the state is t and he
chooses action c 2 [0. 1] is (c t)
2
and the Senders payo is (c (t + /))
2
where
/ =
1
16
. Let (:. c. j) be a perfect Bayesian equilibrium where : 2 [0. 1] ! [0. 1]
and c : [0. 1] ![0. 1] and j : [0. 1] ![0. 1].
(a) Show that there is no PBE in which the Sender always reports half of the state,
i.e. a pure strategy :(t) =
1
2
t for t 2 [0. 1].
(b) Show that every PBE in this game partitions the state space. That is, for
any PBE (:

. c

. j

) there exists 0 t
0
< ... < .t
n
= 1 where c

(:

(t)) =
c

(:

(t
0
)) for all t, t
0
2 (t
i
. t
i+1
).
(c) Find an equilibrium with a partition of size 2 for the game with / =
1
16
. What is
the size of the partition for the most informative equilibrium when / =
1
16
.
4