Microeconomics -- Theory for Individual Choice and Game Theory

Exercises in Game theory, Part II: Dynamic games of complete information Problem 1: Consider a voting game in which three players, 1, 2, and 3, are deciding among three alternatives A, B, and C. Alternative B is the "status quo" and alternatives A and C are "challengers". At the first stage, players choose which of the two challengers should be considered by casting votes for either A or C, with the majority choice being the winner and abstentions not allowed. At the second stage, players vote between the status quo B and the winner of the first round. Players vote simultaneously in each round. The players care only about the alternative that is finally selected, and are indifferent as to the sequence of votes that leads to a given selection. The payoff functions are
u1 ( A) = u 2 ( B) = u3 ( C) = 2

u1 ( B) = u2 ( C ) = u3 ( A) = 1 u1 ( C) = u2 ( A) = u3 ( B) = 0 . (a) (b) What would happen if at each stage the players voted for the alternative they would most prefer as the final outcome? Find the subgame-perfect equilibrium outcome that satisfies the additional condition that no strategy can be eliminated by iterated weak dominance. Indicate what happens if dominated strategies are allowed.

Problem 2: Consider the following two-person game. First Player 1 chooses OUT or IN. If he chooses OUT, the game ends and both players get a payoff of 0. If he chooses IN, Player 2 gets to choose between LEFT and RIGHT and then, finally, Player 1without learning Player 2's choicealso gets to choose between LEFT and RIGHT. If the players choose the same alternative, each gets a payoff of -3. If they choose different alternatives, the player choosing LEFT gets 2 and the one going RIGHT gets -1.

(a) (b) (c)

Give the extensive and strategic forms of the game. Which strategies can be eliminated by repeated weak or strict dominance? Find all subgame perfect equilibria and all other Nash equilibria.

Problem 3: Let G be a static two-person game with pure strategy sets S1 and S2 and $ $ payoff functions u1 and u2 . Assume G has a unique Nash equilibrium s and that s is strict. Let G' be a dynamic variant of G where Player 1 moves before Player 2. Thus G' consists of the following steps:

(i) Player 1 chooses s1 in S1 . (ii) Player 2 is informed about Player 1:s choice in (i). (iii) Player 2 chooses s2 in S2 . (iv) The players' payoffs are u1 ( s1 , s2 ) resp. u2 ( s1 , s2 ) .

(a)

Assume G' has a unique backward induction solution s' . Show that there is a "first-mover advantage" in the sense that
$ u1 ( s' ) u1 ( s ) .

(b)

Now assume in addition that G has continuous best-reply functions. Find sufficient conditions for a strict first-mover advantage, i. e.
u1 (s ') > u1 (s ) .

Problem 4: Consider a game between Firm 1 who is a monopolist on a market and Firm 2 who is a potential entrant. Firm 2, but not Firm 1, has to incur an irretrievable cost F > 0 before acting on the market. Market demand is given by

p(q1, q2) = 16 (q1 + q2) where qi is Firm i's quantity. The timing of decisions is as follows: To start, Firm 1 chooses its quantity q1. Firm 2 observes q1 and then chooses IN or OUT. After choosing IN, 2 also chooses its quantity q2 and the game ends. If 2 chooses OUT, we have q2 = 0 and the game ends. Each firm's profit is given by its total revenues (minus the fixed cost F for Firm 2 if it chooses IN). (a) Explain in words, without any calculations, how the solution to the game is determined. (b) Show that three qualitatively different solutions obtain for F = , F = 5 and F = 20. (c) Consider a variant with the following timing: First 2 chooses IN or OUT. Then 1 observes this choice. Finally the firms choose quantities q1 and q2 simultaneously. Explain in words how the solution to this variant is determined and examine how the answer to (b) is affected.
Problem 5: The static game below is played twice, the outcome of the first stage being observed before the second stage begins. There is no discounting. Show that there exists a subgame perfect equilibrium of the repeated game where (B, R) is chosen at the first stage.
L 1 T 3 1 M 2 2 B 1 0 4 1 1 3 4 0 2 5 1 C 0 R 0