Exercises on Game Theory

Recap Game theory

ˆ (Strictly) Dominant strategy: a strategy si that gives a (strictly) higher payoff than any
other strategy ti , no matter what other players do.

ˆ (Strictly) Dominated strategy: a strategy si that gives a (strictly) lower payoff than some
other strategy ti , no matter what other players do.

ˆ Fact: If a strategy is (strictly) dominant, then all the others are (strictly) dominated.

ˆ Procedure: Eliminate iteratively strictly dominated strategies.

ˆ Nash equilibrium: a strategy profile s∗ = (s∗1 , . . . , s∗n ) = (s∗i , s∗−i ) such that each player’s
strategy s∗i is optimal, given that the others play their equilibrium strategy s∗−i . Equivalently, each
player plays a best reply to the strategy of the others. Equivalently, no player has a profitable
unilateral deviation from the equilibrium.

ˆ Fact: It is without loss to eliminate strictly dominated strategies before finding the Nash equi-
libria.

ˆ Subgame perfect equilibrium: A strategy profile found by applying Backward Induction in a

game tree. The SPE are Nash equilibria of the game and of every subgame.

ˆ Repeated game: The same game is played over and over. Players maximise the Net Present
Value of their flow of payoffs.

ˆ Trigger equilibrium: The strategy profile that Cooperates as long as the other does, and
Defects forever otherwise, is an equilibrium of the repeated Prisoners’ Dilemma for an interval of
discount factors close to 1.

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Exercises
Exercise 1

Find all the Nash equilibria.

1.
Player 1/Player 2 L R
U 10, 0 4, 8
D 4, 2 3, 2

2.
Player 1/Player 2 L R
U 0, 0 1, 0
D 0, 1 2, 2

3.
Player 1/Player 2 L R
U 3, −5 1, 0
D 0, 1 2, 2

4.
Player 1/Player 2 L R
U 0, 0 −20, −20
D −100, −100 2, 2

Find the equilibrium through iterated elimination of dominated strategies

Player 1/Player 2 L M R
U 2, 5 2, 10 3, 0
M 1, 2 1, 0 10, −2
D 1, 2 4, 6 0, 4

Exercise 2

Consider the following game.

P1/P2 L R
U A, −1 B, 1
D C, 1 D, −1

1. For which values of A, B, C, D does this game have two Nash equilibria?
2. For what values of A, B, C, D does this game have one Nash equilibrium?
3. For what values of the same parameters does this game have no Nash equilibrium?

Exercise 3

Two firms operate in the chocolate industry. Each can sell low (L), average (A) or high (H) quality.
If they produce in the same quality segment, the competition will be very severe and and the price
will be below the total average costs in the segments of low and average quality, resulting in losses. In
the segment of high quality, the demand of high revenue consumers allows to maintain the price at a
sufficiently high level to guarantee profits for the two firms. The payoffs are:

Firm 1 / Firm 2 L A H
L -20, -30 1, 15 60, 70
A 15, 1 -10, -5 70, 35
H 10, 80 70, 35 50, 50

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 1. What are the Nash equilibria?

2. Which strategy profile maximizes the sum of profits?

3. Which firm benefits most from the maximization of joint profits? What sum can it offer to
convince the other to collude?

Exercise 4

Airbus and Boeing consider starting a new project in the jumbo jet carriers segment. The profitability
depends on their respective moves and is given in the following table (in millions of dollars, Airbus in
rows, Boeing in columns):

A\B Produce Not produce

Produce - 10, -40 250, 0
Not produce 0, 200 0, 0

1. Find the Nash equilibria of this game.

2. Suppose that Airbus receives a subsidy of 50 millions of dollars if the firm produces. Rewrite the
payoff table and determine the new Nash equilibrium. Comment.

Exercise 5 Simultaneous vs. sequential choices

Let the matrix of payoffs be:

P l.1\P l.2 left right

high 8, 8 3, 10
low 7, 4 2, 3

1. Determine the equilibria of this game if the agents make their choice simultaneously.

2. Suppose now that the player 1 (the Row player) makes his choice before that of Player 2 (the
Column player) and that this choice is observable. Does the new equilibrium correspond to the
one found previously?

Exercise 6 The role of agendas

This example is adapted from a real case. A seat is free at the supreme court of the United States.
There are 3 candidates: B, K and G (Bork, Ginsberg and Kennedy). 3 senators play a crucial role in
the decision process. The seat can remain vacant (V ) if the senators decide in this way. The preferences
of senators 1, 2 and 3 are the following:

1 : K≻V ≻B≻G
2 : G≻K≻V ≻B
3 : V ≻B≻G≻K

The agenda was set in the following way. First, the senators decide by vote if B should or not be
chosen. If this is not the case, the next on line is G. Finally if G is not voted in, the senators can
choose K or keep the seat vacant. Each stage of voting is simultaneous.

1. What is the result of this game if you apply the reasoning by backward induction?

2. If the senators can choose between the result of the preceding question and keeping the seat
vacant, what would they choose?

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 3. Why is the agenda important?

Exercise 7 The pirates’ game

5 pirates want to divide a hoard of 100 coins. The oldest proposes a following method: the pirates are
ordered by from oldest to youngest. In the first round, pirate 1 proposes a division (n1 , . . . , n5 ) of the
hoard. The pirates then vote. Each can accept or reject the proposal. If the proposal obtains strictly
more than half of the votes, it is accepted. If it is rejected, pirate 1 is killed and the procedure restarts
with the pirates 2,3,4 and 5 (until the last one is alive if necessary). Analyze this game.

Exercise 8 Boeing-Airbus

Boeing and Airbus, the world leaders in the aircraft industry, think about introducing an innovation
which can accelerate the takeoff of aircraft and increase the profits of airlines. The possible actions for
each of the two firms is either to innovate (I), or not to innovate (N). Given its technological advantage
on the market, Boeing has the opportunity of moving first.
In the case where Boeing innovates but Airbus does not, the payoffs are X for Boeing and 6 for Airbus,
whereas if Airbus innovates as well, Boeing receives 4 and Airbus Y . If Boeing does not launch the new
system but Airbus does it, the payoffs are 3 for Boeing and Y3 for Airbus; the payoffs will be 2 and 2
respectively if Airbus does not launch the system either.

1. Represent this game in the form of a tree (the extensive form).

2. Verify under what conditions (on X and/or on Y) Airbus and Boeing innovating is a subgame
perfect Nash equilibrium (i.e., calculated by backward induction).
3. Represent this game in the matrix form. Assuming 2 > X and using the bound on Y determined
in part 2, which are the Nash equilibria, and which of them are credible?

Exercise 9 The hold-up problem

Two firms A and B have a joint venture. Such a project requires an initial investment (that is made
simultaneously) of 2 by each firm and generates total revenues of 8. Once this investment is realized in
a second stage each firm can take simultaneously a costly decision (at a cost of 3) which can influence
the division of revenues. If only one of the two firms takes this decision, it captures the totality of
revenues. If both firms pay this cost, they divide the revenues equally. If none makes the decision, the
revenues are divided equally as well.

1. Draw the table (or the matrix) of profits of firms once the investment is made (remember about
the initial investment cost).
2. Determine the equilibrium of this (sub)game. What type of game you know does it resemble?
3. Draw the game tree of the entire game. Will the firms invest in this joint project? Comment on
the name given to this problem.

Exercise 10 Laptops (from past exam)

Alice and Bob own the same type of a portable computer. Unfortunately, both computers were stolen.
The insurance company wants to reimburse them at a fair price and proposes the following rule. Alice
and Bob both announce the estimated value of her/his computer, with possible values {4, 5, 6, 7, 8}
(hundred of euros). The insurance company will reimburse to both the lowest announced price and if
the announcements are not equal, it will give a bonus to the one announcing the lowest value and will
punish the one announcing the higher value.
The choices are made simultaneously. Suppose x is the value announced by Alice and y the value
announced by Bob.

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 ˆ If x = y then each receives her/his announcement.

ˆ If x < y then Alice receives x + 2 and Bob receives x − 2.

ˆ If x > y then Alice receives y − 2 and Bob receives y + 2.

1. Draw the payoff table and find the equilibria of the game.

2. What are the Nash Equilbria of the game?

3. If Alice and Bob can agree on the announcements and divide the sum of the gains, what would
they choose?

4. Suppose now that Alice plays before Bob. Draw the game tree. How will they play this game?
Do they prefer to be first or last to make an announcement?

Exercise 11 Ultimatum game

There is a seller and a buyer. The seller can produce one item at cost c > 0. The buyer valuation for
the item is v > c. If the seller and the buyer agree on a price p, the payoff of the seller is p − c, the
payoff of the buyer is v − p. If there is no trade, the payoff is 0 for each.

1. In a first scenario, the seller proposes a price p in a take-it or leave-it offer. If the buyer accepts,
the item is sold at price p. If the buyer rejects the offer, there is no trade. What is the outcome
of this sequential game?
(Assume that c, p, v are integers, in cents of Euros. For interpretation, think that 1 cent is small
with respect to v − c.)

2. In a second scenario, it is the buyer who has the power to make a take-it or leave-it offer. What
is the outcome then?

3. In experiments on the ultimatum game, the experimenter asks two people to share a prize of 100
euros. The experimenter designates a player 1 and a player 2. Player 1 proposes a take-it or
leave-it sharing of the prize. Both player get nothing if player 2 rejects the proposal. What does
backward induction predict? How do you think real people behave in such situation?

Exercise 12 Joint contributions

Two neighbours have been asked for voluntary contributions for the renovation of the road in front of
their houses. Each has the choice between making a small or a large contribution. If both make small
contributions, the funds are insufficient, so no work is done on the road, and both have a profit of 0.
If either one of the residents makes a large contribution, then the work can be carried out, the profit
for that resident being 1 (once the contribution is deducted) and the profit for the other resident, who
has use of the road whilst having contributed little, is 4. Finally, if both make large contributions,
then they share the costs, and each has a profit of 3.

1. Write down the game matrix for this situation (ie. the profits obtained by each of the agents under
each of the possible strategy configurations).

2. Find all the Nash equilibria of this simultaneous game.

3. Suppose that the two residents can come to an agreement to maximise their total well-being. What
are their choices now?

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In the light of this situation, the mayor decides to impose a local tax of 2 on each resident, under the
following conditions: if the resident makes a large contribution to the common project, then he gets a
full tax rebate, and if the resident makes a small contribution, then his tax contribution is paid to the
other resident.
4. Write down the matrix for this simultaneous game. Does this policy lead to an improvement in the
state of the road?

Now suppose that the choices to contribute are made sequentially and in public: one of the residents is
asked for his contribution first, then, seeing his contribution, the other decides how much to contribute.
The tax is still in place.

5. Write down the game tree for this situation. Solve the game by backward induction. Is it better to
be asked to contribute first or second?

6. Find all the Nash equilibria of this sequential game.

Exercise 13 Games and contracts (from past exam)

A software developer - producer (Player 1) offers a new product to one of its clients (Player 2). The
producer can invest 8 in R&D to offer a new version of the software (N ), or decide to sell an obsolete
product (O) that is just repackaged to look new (which costs nothing). The client can decide to buy a
complete version of the software (C) or one with reduced capabilities (R).
The complete version (of any software) will be sold at 20 to the client. The client will obtain a revenue
equal to 40 if the software is really new, but only equal to 10 if it is obsolete.
The package with reduced capabilities is sold at 10 to the client and will allow the latter to obtain a
revenue equal to 20 if it has new features. Otherwise, the customer’s profit will be only 10.

1. Suppose that the game is played simultaneously. Justify in details that the game matrix with the
net profits for both players is the following.

Producer (Player 1) \ Customer (Player 2) C R

N 12, 20 2, 10
O 20, −10 10, 0

2. What is/are the Nash Equilibrium/ia? Explain by providing details of your argument (only this
will receive full credit). Does any player have a dominant strategy?

3. Suppose that the investment decision by the producer is made first and the customer can observe
the decision. Draw the game tree. What solution do you find by backward induction (i.e., what
is/are the Subgame-Perfect Equilibrium/ia)?

4. And what if it is the customer who moves first and the software developer can observe later the
decision of the client? Draw the game tree and solve the game by backward induction.

5. Suppose that now the customer asks the producer to sign the following contract that will bind the
two parties. If the producer agrees to sign, he commits to invest and develop the new product,
while the customer commits to buy it for 30 later on (same price of 30 for either the complete
or reduced version). The adherence to the contract is controlled by an impartial government
agent (so it will be executed for sure). If the producer denies to sign the contract, they will play
the simultaneous game from question 1 (i.e., the players will not observe the moves by the other
player prior to making their own). Will the software developer sign such a contract?

6. Is this contract optimal for the client? Could he suggest a better one? Explain.

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Exercise 14 Repeated game

Two firms (Philip Morris and Marlboro) simultaneously choose their levels of advertising expense. More
specifically, they choose between advertise (A) or not (N). The matrix of payments is as follows:

PM/Marlboro Advertise (A) Not advertise (N)

Advertise (A) 5, 5 12, 3
Not advertise (N) 3, 12 10, 10

1. What famous game does this game resemble? What is the Nash equilibrium of this game?

2. Philip Morris and Marlboro create a surprise by deciding to jointly lobby in favor of a ban on
advertising in the tobacco industry. Do you find it surprising?

3. Suppose now that both firms indefinitely play this game. Every month, they can choose their
advertising expense. Suppose that the monthly discount factor is δ = 1/2 (this means that the
present value of receiving one euro in a month from now is 1/2). Is it possible to sustain an
equilibrium in which firms never advertise?