Dr.

Lawrence Choo, Simeon Schchtele SS 2016/17

Advance Game Theory

Exercise 1.1
Consider the following prisoners dilemma in simple payoffs.
player 2
C D
C 5, 5 0, 8
player 1
D 8, 0 2, 2
Utility over payoffs for each player i is:

ui (xi , xi ) = xi max{xi xi , 0} max{xi xi , 0}

where , 0 and .
(a) For what values of and is (C; C) a Nash equilibrium?
(b) For which of these values is (D; D) also a Nash equilibria? Explain.

Exercise 1.2
Consider an oligopoly with three firms located in Germany producing a homogenous product. Each firm
has a cost function C(qi ) = cqi where qi is the production quantity
P of firm i = 1, 2, 3. The German
market inverse demand function is P (Q) = A BQ where Q = i qi and A > B > c > 0.
(a) Find equilibrium outputs and profits for each firm in a sequential game in which firms 1 and 2 are
the market leaders. That is, firms 1 and 2 first simultaneously choose their output quantities. Upon
observing the quantities of firms 1 and 2, firm 3 chooses its output quantity.
(b) Firm 3 is considering to relocate to France. If it does so, it will still compete in the same German
market as firms 1 and 2. There are no transportation cost or tariffs and the market inverse demand
function remains unchanged. However, firm 3 will no longer be able to observe the output quantities
of firms 1 and 2 before choosing its own output this is a common knowledge fact. An independent
expert determines that the relocation cost for Firm 3 will be (Ac)2 /(10B). Will a profit maximising
firm 3 relocate?

Exercise 1.3
Consider the following extensive form game. Find the pure strategies Nash equilibria, Subgame-Perfect
equilibria and Weak Perfect Bayesian equilibria.
1 A
B C (3, 11)
2 2
a b a b

(2, 5) (5, 4) (2, 6) (6, 7)

A B

2
(0, 0)
a b

1 1

C D C D

(3, 1) (2, 0) (2, 1) (1, 10)

Figure 1: Extensive form game for question 1.4(a)

O I

2
(2, 2, 2) A C
B
3
(4, 3, 1)
X Y X Y

(1, 2, 6) (7, 5, a) (3, 2, 1) (5, 0, b)

Figure 2: Extensive form game for question 1.4(b)

Exercise 1.4
For the following two parts, consider only pure strategies.
(a) Consider the 2 player extensive form game in Figure 1. Find the nash equilibria, subgame perfect
equilibria and weak-perfect bayesian equilibria.
(b) Consider the 3 player extensive form game in Figure 2.
1. Find all subgame perfect equilibria when a = 5 and b = 0.
2. Find all subgame perfect equilibria when a = 0 and b = 5.

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Exercise 1.5
There are two players, Player 1 and Player 2. Player 1 can choose between the actions U and D. Player
2 can choose between the actions L and R. The payoffs to each player depends on their type. Player 1
can be of type 1 = {L, H}. Player 2 can only be of type 2 = L. Nature determines the types for each
player with the probabilities (p(1 , 2 )): p(L, L) = 31 and p(H, L) = 32 . Figure 3 details the payoffs to
each player depending on their types. For the following two parts, consider pure strategies only.

Player 2 Player 2
L R L R
U 2, 0 0, 3 U 4, 3 1, 1
Player 1 Player 1
D 5, 4 20, 0 D 2, 0 2, 20
Types: 1 = L, 2 = L Types: 1 = H, 2 = L

Figure 3: 2 player game for question 4

(a) Assume that Player 1 does not observe his type Player 2 also does not observe Player 1s type.
Find the bayesian nash equilibria and payoffs (if any).
(b) Suppose that Player 1 observes his own type, but Player 2 does not observe Player 1s type. Find
the bayesian nash equilibria and payoffs (if any).

Exercise 1.6
Two students are working on a joint project to which each of them contributes labor input li [0, 1].
The productivity of student 2 is common knowledge, whereas that of student 1 is private information
(i.e., it is known only to student 1). A priori, this productivity can be either high with probability p or
low with probability 1 p. Both students decide simultaneously how much labor input to dedicate to
the project. The value of the project depends on the labor input of the two students. It is given by the
following function: (
2l1 + l2 if student 1 is highly productive
y(l1 , l2 ) =
l1 + l2 otherwise
Given the students labor contributions and the induced value of the project, each student i {1, 2}
obtains a utility Ui (li , y) = (1 li )y 2 .
Formulate the situation as a Bayesian game. Compute the students labor contributions in the Bayes-
Nash equilibrium.

Exercise 1.7
Two individuals live in neighboring houses at a remote and isolated location. They consider whether to
build a paved road that would connect their houses to a nearby highway. Building this road is known to
cost 30. An individual has interest in building the road only if she is planning to buy a car, in that case
the monetary value of the road to her is 50 and it is zero otherwise. An individual is planning to buy a
car with probability p and is not planning to buy one with probability 1 p. Each individuals plan to
buy a car is her private information (i.e. it is known only to her but not to the other individual).
The two individuals make a decision about building the road or not in a sequential way. First, individual
1 indicates how much she is willing to contribute to the financing of the road, that is, any amount 1
between 0 and 30. Second, individual 2 observes individual 1s proposed contribution and can decide
whether she is willing to pay the difference 30 1 or not. If individual 2 agrees to pay the difference, the
road is built with the contributions of individual 1 and 2 being 1 and 30 1 , respectively. If individual
2 refuses to pay the difference, no paved road is built and everybody obtains zero.
1. Represent this game in extensive form.

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 2. Determine the Bayes-Nash equilibrium.
3. Specify the values of p for which the mechanism yields an efficient solution.
4. Argue: Why is the free-rider problem more severe if p is high?

Exercise 1.8
Consider extensive form game in Figure 4. Here, Player 1 can be of type 1 or 2 with equal probability.
Upon knowing his own type, Player 1 can choose action l or r. Player 2 observes Player 1s action but
not his type. Player 2 can choose action u or d.
(a) Find the pure strategy separating equilibria (if any).
(b) Find the pure strategy pooling equilibria (if any).
(c) Assume that the probability of Player 1 being type 1 is now 9/10. Will this change any of your
equilibrium predictions from parts (a) and (b)?

(1, 3) (2, 1)

u u

l Player 1 (type 1) r

d 1 d
2
(4, 0) (0, 0)

Player 2 Nature Player 2

(2, 4) (1, 0)
1
2
u u

l Player 1 (type 2) r

d d
(0, 1) (1, 2)

Figure 4: Extensive form game for question 1.8

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Exercise 1.9
Three players are bidding for a painting by Claude Monet. Each player has a private, independent value
vi that is drawn uniformly from the interval [0, 1] (in millions of euros). However, there is a probability
of 1/2 that the painting is a fake and worthless to all.
(a) Compute the equilibrium bid function in a first-price auction.
(b) A relative of the seller suggested that he will do better (i.e., get higher expected revenues) if he had
instead used the third-price auction format. Do you agree with this? Briefly explain.
(c) The seller has decided to follow the advise of his relative and use a third-price auction. Compute his
expected revenue.
(d) A relative of the seller also suggested that by imposing a reserve price r > 0 in the third-price
auction, the seller can further improve his expected revenue and the auction will still be efficient.
Do you agree with this? Briefly explain.

Exercise 1.10
Suppose that there are n bidders participating in an auction, where the private values V1 , V2 , .., Vn
are independent and identically distributed, with the cumulative distribution function Fi (vi ) = vi2 for
v [0, 1].
(a) Find the equilibrium bid (bi ) in the first, second and all pay auction.
(b) Derive the expected revenue for the seller.

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