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Lectures 15-18

Muhamet Yildiz

Demand:

P (Q) = a Q

where Q = q1 + q2 .

The marginal cost of Firm 1 = c1 ; common knowledge.

Firm 2s marginal cost:

cH

with probaility ,

cL

with probaility 1 ,

Each firm maximizes its expected profit.

How to find the Bayesian Nash Equilibrium?

Firm 2 has two possible types; and dierent actions will be chosen for the two dierent

types.

{q2 (cL ), q2 (cH )}

Suppose firm 2 is type high. Then, given the quantity q1 chosen by player, its problem is

max(P cH )q2 = [a q1 q2 cH ] q2 .

q2

Hence,

q2 (cH ) =

a q1 cH

2

1

(*)

max [a q1 q2 cH ] q2 ,

q2

hence

a q1 cH

.

2

Important Remark: The same level of q1 in both cases. Why??

q2 (cL ) =

(**)

Firm 1s problem:

max [a q1 q2 (cH ) c] q1 + (1 ) [a q1 q2 (cL ) c] q1

q1

[a q2 (cH ) c] + (1 ) [a q2 (cL ) c]

2

q1 =

q2 (cH ) =

(***)

a 2cH + c (1 )(cH cL )

+

3

6

q2 (cL ) =

q1 =

a 2cL + c (cH cL )

+

3

6

a 2c + cH + (1 )cL

3

vi : valuation of bidder i.

Let us assume that vi s are drawn independently from a uniform distribution over [0, 1]. vi

is player is private information. The game takes the form of both bidders submitting a bid,

then the highest bidder wins and pays her bid.

Let bi be player is bid.

vi (b1 , b2 , v1 , v2 ) = vi bi if bi > bj

vi bi

2

if bi = bj

0 if bi < bj

1

max(vi bi )P rob{bi > bj (vj )|given beliefs of player i) + (vi bi )P rob{bi = bj (vj )|...)

bi

2

Let us first conjecture the form of the equilibrium: Conjecture:

equilibrium

2

b = a + cv.

Then, 12 (vi bi )P rob{bi = bj (vj )|...) = 0. Hence,

bi

(vi bi )P rob{vj

bi a

(bi a)

} = (vi bi )

c

c

FOC:

vi + a

if vi a

2

=a

if vi < a

bi =

(1)

1

bi = vi .

2

Double Auction Simultaneously, Seller names Ps and Buyer names Pb . If Pb < Ps , then no

trade; if Pb Ps

trade at price p =

Pb +Ps

2 .

Vb uniform over (0, 1)

Vs uniform over (0, 1) and independent from Vb

Strategies Pb (Vb ) and Ps (Vs ).

The buyers problem is

Pb + Ps (Vs )

: Pb Ps (Vs ) =

maxE Vb

Pb

2

max Vb

P rob{Pb Ps (Vs )}

Pb

2

where E[Ps (Vs )|Pb Ps (Vs )] is the expected seller bid conditional on Pb being greater than

Ps (Vs ).

Ps + Pb (Vb )

Vs : Pb (Vb ) Ps ] =

Ps

2

max

Vs ] P rob{Pb (Vb ) Ps }

Ps

2

maxE

Equilibrium is where Ps (Vj ) is a best response to Pb (Vb ) while Pb (Vb ) is a best response to

Ps (Vs ).

There are many Bayesian Nash Equilibria. Here is one.

Ps = X

if

Pb = X

if

Vs X

Vb X.

Why is this an equilibrium? Because given Ps = X if Vs X, the buyer does not want to

Vb

Vb /Vs

Trade

Efficient

not to trade

0

Inefficient

lack of equilibrium

pb = ab + cb vb

ps = as + cs vs ,

VS

Likewise, ps pb (vb ) = ab + cb vb i

vs

pb as

.

cs

vb

ps ab

.

cb

pb + ps (vs )

: pb ps (vs )

maxE vb

pb

2

Z pb as

cs

pb + ps (vs )

= max

vb

dvs

pb

2

0

Z pb as

cs

pb + as + cs vs

dvs

= max

vb

pb

2

0

Z pb as

cs

cs

pb as

pb + as

vb

= max

vs dvs

pb

cs

2

2 0

cs pb as 2

pb as

pb + as

vb

= max

pb

cs

2

4

cs

pb as

pb + as pb as

vb

= max

pb

cs

2

4

pb as

3pb + as

= max

.

vb

pb

cs

4

F.O.C.:

1

cs

3(pb as )

3pb + as

vb

=0

4

4cs

i.e.,

2

1

pb = vb + as .

3

3

Similarly, the sellers problem is

1

There is somewhat simpler way in to get the same outcome; see Gibbons.

(2)

Z 1

ps + ab + cb vb

ps + pb (vb )

vs : pb (vb ) ps = max p a

vs dvb

maxE

s

ps

ps

b

2

2

cb

Z

ps + ab

ps ab

cb 1

vs +

= max 1

vb dvb

ps

cb

2

2 ps ab

cb

ps ab

ps + ab

cb

ps ab 2

vs +

= max 1

1

ps

cb

2

4

cb

ps + ab

cb ps ab

ps ab

= max 1

vs + +

ps

cb

2

4

4

ps ab

3ps + ab

cb

= max 1

vs +

ps

cb

4

4

F.O.C.

1 3ps + ab

3

ps ab

1

vs +

+

1

=0

cb

4

4

4

cb

i.e.,

3

cb

3ps + ab

vs +

+ (cb (ps ab )) = 0,

4

4

4

i.e.,

ab

3ps

cb 3

ab + cb

= + vs + (cb + ab ) = vs +

2

4

4

4

2

i.e.,

2

ab + cb

.

ps = vs +

3

3

By (2), ab = as /3, and by (3), as =

ab

3

(3)

pb =

ps =

2

1

vb +

3

12

2

1

vs + .

3

4

(4)

(5)

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