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206 HW7 Extensive Signaling Solution

206 HW7 Extensive Signaling Solution

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Published by Chumba Museke
game theory
game theory

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Published by: Chumba Museke on Oct 23, 2012
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12/04/2012

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Problem set 7: Equilibria in extensive-form games1. (a)
By backward induction, in period 2:
1
2
arg max
q
2
0
[
2
(1
1
2
)]
2
(
1
) =
1
q
1
2
if 
1
10 otherwise
.
And thus in period 1:
1
arg max
q
1
0
[
1
(1
1
2
(
1
))]
1
=12
2
=14
.
This path yields
π
1
=
18
and
π
2
=
116
. We also need to check the other paths sincethe FOC for player 2 might yield negative payoff on the other paths.
2
For each
1
(each player 2’s history), if firm 2 chooses the quantity derived by the FOC, itspayoff is1
1
2
1
1
1
1
2
=(1
1
)
2
4
0
.
Thus, both players have no incentive to deviate from the following strategy profile:
1
=12
,
2
(
1
) =
1
q
1
2
if 
1
10 otherwise
,
which is SPE.
(b)
We can write firm 2’s (discontinuous) profit function:
3
π
2
(
1
,
2
) =
2
(1
1
2
)
if 
2
>
00 if 
2
= 0
1
We assume
1
,
2
0. If there is no restriction, the question will be easier.
2
Of course, in this question, we do not need to worry about this by the form of the payoff function, unlikepart (b).
3
Here, we assume that
2
= 0 means “staying out.”
1
 
Since FOC for
2
>
0 does not change, if firm 1 chooses
1
=
12
as before, firm 2chooses
2
=
14
and thus
π
2
=
116
. Firm 1 earns
π
=
18
.However, firm 1 may prefer to deter entry, that is, we need to check the otherpaths as in part (a). For each
1
(each player 2’s history), if firm 2 chooses thequantity derived by the FOC, its payoff is
2
(
1
)(1
1
2
(
1
))
=(1
1
)
2
4
f.
If 
(1
q
1
)
2
4
, that is, 1
2
√ 
1
1 + 2
√ 
, firm 2 weakly prefers inaction.Note that, since 0
(1
q
1
)
2
4
, we can always find such
1
in this case. Since
f <
116
, we have
12
<
1
2
√ 
1
. When
2
= 0, firm 1’s payoff is globallymaximized at
1
=
12
. This argument implies that if 
(1
q
1
)
2
4
, firm 1’s optimalaction is
1
= 1
2
√ 
1, which yields
π
1
= (1
2
 
)
1
(1
2
 
)
= 2
 
(1
2
 
)
18if 2
√ 
28
 
2 +
√ 
28
.
If 
is sufficiently close to
116
, the above inequality is satisfied. Since 1+2
√ 
1,SPE is as follows:
1
=
1
2
√ 
if 
2
√ 
28
√ 
(
<
14
<
2+
√ 
28
)
12
if 
2
√ 
28
>
√ 
 
f,
2
(
1
) =
0 if 
1
1
2
√ 
1
q
1
2
if 
1
<
1
2
√ 
 
f.
Intuitively, if the fixed cost is high, the firm 1’s cost of deterring entry is low andso it is worthwhile for firm 1 to do so.
4
4
When firm 1 chooses 1
2
√ 
, it would hope that firm 2 chooses 0 but it is not strictly guaranteed since
1
q
1
2
is also optimal for firm 2 and this is a strictly worse choice for firm 1 if 
f >
0. One might think aboutslightly larger quantity of firm 1 than 1
2
√ 
to guarantee the better choice, that is,
2
= 0, but, in thiscase, we can always find a better action, which means this cannot constitute SPE.
2
 
2.
First, it is straightforward to check that the strategy pair defined in the question isa subgame perfect equilibrium as in Proposition 122.1. Actually, we can show thisgame satisfies the one deviation property (Exercise 123.1 in MOAR). In the proof of Lemma 98.2 in MOAR, we suppose one profitable deviant strategy
s
i
of player
i
infinite subgame Γ(
h
) but we can apply this logic to this game since any infinite subgamein this game yields the worst outcome. This implies that we can ignore any infinitepath when you consider some profitable deviation.Second, we show the uniqueness.
Step 1
.
1
(
G
1
) =
m
1
(
G
1
) = 1 and
2
(
G
2
) =
m
2
(
G
2
) =
c
1
.Let
i
(
G
i
) and
m
i
(
G
i
) be as in the proof of Proposition 122.1 in MOAR for
i
= 1
,
2.By the argument for (124.1) in MOAR with the roles of the players reversed we have
2
(
G
2
)
1
m
1
(
G
1
)+
c
1
, or
m
1
(
G
1
)
1
2
(
G
2
)+
c
1
. Now suppose that
2
(
G
2
)
c
2
. Then by the argument for (123.2) in MOAR with the roles of the players reversedwe have
m
1
(
G
1
)
1
2
(
G
2
)+
c
2
, a contradiction (since
c
1
< c
2
). Thus
2
(
G
2
)
< c
2
.But now the argument for (123.2) implies that
m
1
(
G
1
)
1, so that
m
1
(
G
1
) = 1 andhence
1
(
G
1
) = 1. Since (124.1) implies that
2
(
G
2
)
1
m
1
(
G
1
) +
c
1
we have
2
(
G
2
)
c
1
; by (123.2) we have
m
2
(
G
2
)
c
1
, so that
2
(
G
2
) =
m
2
(
G
2
) =
c
1
.The remainder of the argument follows as in the proof of Proposition 122.1 in MOAR:
Step 2 
. In every SPE of 
G
1
player 1’s initial proposal is 1, which player 2 immediatelyaccepts.
Step 3 
. In every SPE of 
G
1
player 2’s strategy accepts any proposal.
3.
Suppose that player 2 adheres to
tit-for-tat 
. Consider player 1’s behavior in subgamesfollowing histories that end in each of the following outcomes.(
C,
) If player 1 adheres to
tit-for-tat 
the outcome is (
C,
) in every period, so that3

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