GAME THEORY

Problem set C1
Problems on simultaneous and sequential move games of incomplete information
Unless mentioned otherwise, assume the players to be individually rational and risk-
neutral

1. Consider a simultaneous move game between A and B, where each player can be
of either type X or Y. Players know their own types but not the types of other player. A
believes that B is type X with probability 1/2 and B believes that A is type X with
probability 2/3. The Bernoulli payoff matrices for the game (under various states) are given
below:

B B

M N M N

M 2, 1 0, 0 M 2, 0 0, 2
A A
N 0, 0 1, 2 N 0, 1 1, 0

State XX State XY

B B

M N M N

M 0, 1 2, 0 M 0, 0 2, 2
A A
N 1, 0 0, 2 N 1, 1 0, 0

State YX State YY

Write down the type-dependent actions sets for the players.

Make the expected payoff tables for each type of each player.
Find all the Bayesian Nash equilibria of the above game.
2. Player 1 owns a house that he inherited but doesn’t live in. Player 2 would like to
own the house. The value of the house to player 2 is v, which is private information to
player 2. Consider the following bargaining game between player 1 and player 2:
In period I, player 1 makes a price offer p1 that player 2 may either accept or reject. If the
offer is accepted, player 1 gets p1 and player 2 gets v – p1. If player 2 rejects p1, then player
2 makes a counter price offer p2 in period II that player 1 can either accept or reject. If
player 1 accepts the offer he gets p2 and player 2 gets v – p2 – k, where k is player 2’s cost
of waiting for one period. Value of k is also private information to player 2, but player 1
believes that k is uniformly distributed in [kmin, kmax]. If player 1 rejects p2, the negotiation
fails. On negotiation failure player 1 gets her default payoff r and player 2 gets his default
payoff 0. r is the discounted value of cash flow from renting out the house, net of
transaction costs. The default payoffs are common knowledge.
What is the optimal p1 that player 1 should offer, if she is risk neutral?
Under what condition(s) will player 2 accept player 1’s offer, if player 1 had offered her
optimal p1?

3. Consider the following bargaining game between a buyer and a seller; the buyer’s
maximum willingness to pay (which is the monetary value of the buyer’s utility from the
object on sale) is W, which is private information to the buyer.
In period 1, the seller makes a price offer that the buyer may either accept or reject. If the
offer is accepted the seller gets ps and the buyer gets W – ps where ps is the price offered by
the seller. If the buyer rejects ps, then s/he makes a counter price offer pb in period 2 that
the seller can either accept or reject. If the seller accepts the offer s/he gets pb and the buyer
gets W – pb – θ, where θ is the buyer’s cost of waiting for one period. Value of θ is also
private information to the buyer, but the seller believes that θ is 5 with probability ρ, 3 with
probability γ and 2 with probability 0.25. If the seller rejects pb, the negotiation fails. On
negotiation failure the seller gets to sell the good at the market price in period 2. The
expected market price in period 2 is 10, which is common knowledge. Assume that the
buyer and the seller are risk neutral.
Present the situation in form of a game tree, wherein Nature moves first and picks up the
buyer’s type. Specify players, nodes, information sets, actions / moves and payoffs.
Can the seller, who is risk-neutral, offer the price ps = 12 in period 1? Justify your answer.
Find the belief consistent prices that the seller can offer in period 1. Specify the beliefs to
which the prices are consistent. Provide the rationale for your answer.

4. Acme Autos is bargaining with Selco Steel on the price of steel that Acme wants to
buy. Tomorrow the representatives of the two firms will meet to negotiate the price,
wherein Acme will have to make a price offer. Selco’s representative may either accept or
reject the offer made by Acme. In case the price offered by Acme gets rejected, Selco’s
representative will return next Friday with an alternative price, which Acme can either
accept or reject. In the meantime Acme can use its stock of steel, but the stock will run out
on next Friday. If Acme rejects the price asked by Selco on next Friday they will have to
buy steel at the market price, which is expected to be $20 per ton. For each dollar the price
falls (or rises), Acme gains (or losses) $1 million in profit, and Selco losses (or gains) $1
million. Selco's production cost is $3 per ton, and their waiting cost is β million dollars per
week. Acme doesn’t know the value of β, but believes that β = 6 with probability ρ and
that β = 3 with probability (1 – ρ). Assume that both the firms are risk neutral.
Find all the belief consistent price offers of Acme. For each rational offer price, clearly
specify the corresponding belief of Acme to which the offer price is consistent.

5. Consider a wage settlement game where the firm and the trade union
simultaneously quote wages wf and wu. The wage is settled if wf > wu. If wf < wu the dispute
is settled by an arbitrator. The arbitrator has an ideal wage (x) in mind, and simply chooses
the offer that is closer to her / his ideal. This ideal wage (x) is known to the arbitrator, but
not known to the firm and the union. To the firm and the union, x is a random variable that
is uniformly distributed in the interval [wmin, wmax].
Under what condition will the arbitrator accept the wage quoted by the firm?
What is the expected wage if wf < wu?
What wages must the firm and the union ask for respectively, such that the quoted wages
are best responses to each other?
Find the probability that the arbitrator will accept the wage quoted by the firm.