Economics 440/640 Problem Set 1 Answers

All questions are equally weighted.

Question 1. Geometry of Best Response Functions.

For this question, consider two-person games with two strategies for each player: S1 = {Up, Down} and S2 = {Left, Right}

We can represent a mixed-strategy combination as a point in the unit square where x is the probability 2 plays Right and y is the probability that 1 plays Up. For example, the point (3/4, 1/3) represents player 1 playing Up 1/3 of the time and Down 2/3 of the time, and player 2 playing Left 1/4 of the time and Right 3/4s of the time. A) Draw both players best response curves for the following game. L U D 2, 2 1, 0 R 0, 3 1, 1

B) Find payoffs that would produce the following best response diagram. (The solid line is player 1s best response and the dashed line is player 2s). Hint: you may want to work out numbers that will give you the approximate shapes rst and only then focus on the point where the curves intersect.
Pr. Up

(1/2, 1/3)

(0, 0)

Pr. Right

C) Find payoffs that would produce the following best response diagram. 1

Pr. Up (2/5, 4/5)

(0, 0)

Pr. Right

A.

There are two pure-strategy NE, (U, L) and (D, R), which will look like
Pr. Up

(0, 0)

Pr. Right

Because the rst NE is the upper-left entry in the matrix, there is a corresponding intersection of the two BR curves in the upper left, at x Pr(a1 = R) = 0 and y Pr(a2 = U ) = 1. However, the interior intersection will not necessarily be at (1/2, 1/2). Instead we must solve for the third, mixed-strategy NE. This equilibrium makes Player 2 indifferent between L and R: U2 ((p, 1 p), L) 2p 6p p = = = = U2 (p, 1 p), R) 3p + 1(1 p) 1 1/6

Likewise, Player 1 must be indifferent between U and D: U1 (U, (q, 1 q )) 2q 4q q = = = = U1 (D, (q, 1 q )) 1q + 1(1 q ) 1 1/4

so the mixed-strategy NE is ((1/4, 3/4), (1/6, 5/6)). The correct diagram is below.

Pr. Up

(1/4, 1/6)

(0, 0)

Pr. Right

B. Let a through h denote the following payoffs: L U D a, b e, f R c, d g, h

From the diagram (U, L) and (D, R) are NE, which requires For (U, L) : a > e b>d For (D, R) : g > c h>f

And nally we know there is a NE in mixed strategies where Player 1 is indifferent between U and D when Player 2 plays L and R each half the time. For that to be the case, U1 (U, (1/2, 1/2)) = U1 (D, (1/2, 1/2)) a/2 + c/2 = e/2 + g/2 a + c = e + g. Likewise, Player 2s mixed strategy implies U2 ((1/3, 2/3), L) = U2 ((1/3, 2/3), R) b/3 + 2f /3 = d/3 + 2h/3 b + 2f = d + 2h. Any payoffs that satisfy these four inequalities and two equalities are acceptable. For example: 3

L U D 1, 2 0, 0

R 0, 0 1, 1

C. Let a through h denote payoffs as above. When player 1 plays U, player 2 wants to play L, so b > d. However when player 1 plays D, player 2 wants to play R, so h > f . Likewise, e > a and c > g. For the mixed strategy, when player 1 plays U 4/5s of the time, player 2 is indifferent between L and R: U2 ((4/5, 1/5), L) = U2 ((4/5, 1/5), R) 4b + f = 4d + h. When player 2 plays R 2/5s of the time, player 1 is indifferent between U and D: U1 (U, (3/5, 2/5)) = U1 (D, (3/5, 2/5)) 3a + 2c = 3e + 2g. Any answer that satises these six conditions is correct. For instance, L U D 0, 10 20, 10 R 30, 0 0, 50

Question 2. A Patent Race.

Firm 1 and rm 2 each decide on a research investment of ri that is either $0, $1 million, or $2 million. If ri > rj , rm i has a breakthrough worth $5 million while rm j is too late and gets no benet from its research expenditure. If ri = rj , neither rm gets the $5 million gross prot from the breakthrough because it is eaten up by patent disputes. A) Find the normal-form of this game. B) Find the the Nash equilibrum of this game. 4

0 0 1 2 0, 0 4, 0 3, 0

1 0, 4 1, 1 3, 1

2 0, 3 1, 3 2, 2

Figure 1: Question 2 part A. A. See Figure 1.

B. No strategies are eliminated by iterated elimination of dominated strategies, so players place positive weight on all strategies in the (unique) mixed-strategy equilibrium. Let p be the probability player 1 invests 0, q be the probability player 1 invests 1, etc. Then p, q , and 1 p q must make player 2 indifferent to any level of investment: 0 = 4p q 1 + p + q = 3p + 3q 2 + 2p + 2q so 4p q 1 + p + q = 0 5p 1 = 0 5p = 1 or p = 1/5, and 3p + 3q 2 + 2p + 2q 5p + 5q 5(1/5) + 5q 5q =0 =2 =2 =1

so q = 1/5 as well. Both players invest $2 million 3/5s of the time and $1 million and $0 each 1/5 of the time. C. By similar logic, investing $3 or $4 million will not not be eliminated with IEDS. Investing $5 million is weakly dominated by investing $0 million, so players will not invest $5 million. Players place positive weight on $0,$ 1,$ 2,$ 3, and$ 4 million. By analogy to (B), the weight on each investment is 1/5. Note that all prots are competed away in expectation in both (B) and (C). This property is typical of wars of attrition, which this game is an example of. 5

Question 3. Group HW version 3.5

Consider three classmates working a group homework assignment, who simultaneously choose si = S = {S, W }. Assume their nal grade is # of Ws Grade 0 1 0 30 2 3 70 100

and ui = g if si = W or ui = g + 35 if si = S . A) Write this game in matrix form. B) Solve for all pure-strategy Nash equilibria of the game. C) If your solution differs from the group homework example in class on 1/14 (Group HW Version 3), explain intuitively why the outcome in this problem is different. D) Solve for a symmetric mixed strategy Nash equilibrium of the game. I.e., if p1 is the probability that Player 1 Works, and so on, is there a NE in which p = p1 = p2 = p3 ? What is the expected grade in this equilibrium? (More difcult. Note that the probability of n players working is binomially distributed.) A. See Figure 2. W W S 100, 100, 100 105, 70, 70 S 70, 105, 70 65, 65, 30 W S W 70, 70, 105 65, 30, 65 S 30, 65, 65 35, 35, 35

s3 = W Figure 2: Question 3 part A.

s3 = S

B. There are four: three in which two players W and one Ss: (W, W, S ), (W, S, W ), (S, W, W ), and one in which no one works: (S, S, S ).

C. The NE are determined by the marginal value of the nth player. For n players to W , the marginal benet of W , which is g (n) g (n 1), has to be greater than the benet of S , which is 30. In this problem, if one other player is W ing, player i W ing increases her payoff by 40, which is better than the 30 she could get from sleeping instead. In Group Homework Version 3, if two players were working, the marginal benet of W ing was 40, so (W, W, W ) was an equilibrium, while here it is 30, so (W, W, W ) is not an equilibrium. D. Consider the comparison that player i makes between W and S . Let a be the probability than no other players are W ing, b the probability that one other player is W ing, and c the probability that both other players are working. Then Ui (si = W ) = ag (1) + bg (2) + cg (3) Ui (si = S ) = ag (0) + bg (1) + cg (2) + 30 For i to work sometimes and sleep sometimes requires Ui (si = W ) = Ui (si = S ), or a(g (1) g (0) + b(g (2) g (1)) + c(g (3) g (2)) 30 = 0. (1)

a, b, and c are terms from a binomial distribution where 2 trials are conducted with probability of success p (read the Wikipedia article on the binomial distribution if this statement makes no sense to you). Thus a = (1 p)2 , b = 2p(1 p), and c = p2 . Combining these with equation (1) a(g (1) g (0)) + b(g (2) g (1)) + c(g (3) g (2)) 35 30(1 p)2 + 80p(1 p) + 30p2 35 30 60p + 30p2 + 80p 80p2 + 30p2 35 5 + 20p 20p2 = = = = 0 0 0 0

p = 1/2. In this symmetric mixed strategy, each player works half the time and sleeps half the time. The expected payoff is 67.5 from either strategy, so the pure strategy equilibria with two players working Pareto-dominate it. (In turn, it Pareto-dominates the equilibrium in which no one works).

Question 4. Volunteers Dilemma.

The Parliament of the Republic of Nash is made up of two elected ofcials. Being a parliamentarian is a full-time job (there are only two of them!). 7

Both feel like they are overworked relative to their pay. Their current wage gives each of them utility L. If one of them would introduce a bill to increase the salary of members of parliament, they could achieve a higher wage giving each of them utility V . However, the parliamentarian who introduces the bill is going to get angry calls from his constituents, which cost him C utility. A) What is the normal form of this game? B) Find the pure strategies of the game. Do they depend on how large L or V is relative to C ? C) Find the mixed strategies of the game. If you need to assume something about L, V , and C for a mixed strategy to exist, please do so. A symmetric Nash equilibrium is a Nash equilibrium in which 1 = 2 = = n (all players use the same strategy). D) What if Parliament had more than two members? Find the unique symmetric equilibrium of the game as a function of the number of members, N , for all combinations of parameters. A. It resembles a Hawk-Dove game, sort of. Introduce Introduce Not V C, V C V,V C Not V C, V L, L

B. (I, I ) cannot be a NE because necessarily V C < V If V C > L, then the NE are (I, N ) and (N, I ). If V C < L, then the NE is (N, N ). The intuitive interpretation of this condition is that if C is really large, neither parliamentarian wants to stick his neck out and introduce the bill, perhaps because he would not get re-elected. C. If the players mix they have to be indifferent between Introduce and Not. Let p be the chance that the other player introduces. Then V C = pV + (1 p)L V LC . V L Figure 3 depicts the mixed NE. The dashed line is player 1s best response and the solid line is player 2s. p= 8 or

q=1

V LC V L

q=0 p=0

V LC V L

p=1

Figure 3: Best Response Curves in Volunteers Dilemma. D. If V C > L, the only symmetric equilibrium has all members mixing. Let p again denote the chance of introducing legislation. The chance that no one introduces it is (1 P )N and the chance that no one other than a particular member introduces it is (1 P )N 1 . So V C = (1 (1 p)N 1 )V + (1 p)N 1 L. Solving for p, V C = V (L V )(1 p)N 1 C = (L V )(1 p)N 1 C (1 p)N 1 = LV p = 1 C V L
1 N 1

V C > L so C < V L so C/(V L) < 1. If a number x is raised to a power y , xy increases as y falls. C/(V L) is raised to the power 1/(N 1), so p is falling as N increases and rising as C/(V L) falls. These comparative statics make sense if you think about them. The unique symmetric equilibrium for V C < L is more boring. No parliamentarians choose to introduce the bill.