ECON 440/640 Problem Set 4 Answers

Problem 3.3
When bi = bL , i (pi ) is i (pi ) = (a pi bL E [pj ])pi so di = a bL pj 2pi dpi a bL E [pj ] . p i = pL = 2 Likewise when bi = bH ,
p i = pH =

a bH E [ p j ] . 2

The expected price the other rm sets is

E [pj ] = E [p] = p H + (1 )pL

so E [p] = a bL E [ p ] + (1 ) 2 a . E [p] = 2 bL (1 )bH a bH E [p] 2

It is possible to use E [p] to solve for p H and pL , but as far as I can tell, doing so does not lead to anything interesting.

Problem 3.6
The problem asks you to show that in there are n bidders, then the strategy of bidding bi = (n 1)vi /n is a symmetric BNE. Given that everyone plays this strategy, the probability of bi being the winning bid is Pr(bi > max{bj |j = i}) = Pr(bi > b1 ) Pr(bi > b2 ) . . . = Pr(bi > (n 1)v1 /n) Pr(bi > (n 1)v2 /n) . . . = Pr(v1 < nbi /(n 1)) Pr(v2 < nbi /(n 1)) . . . = nbi n1
n1

The rst step follows because for bi to be the maximum bid, it must be greater than each other bid. Using this result, we can rewrite i as i = Pr(bi > max{bj |j = i})(vi bi ) nbi (vi bi ) = n1 n1 nn1 bi vi nn1 bn i = (n 1)n1 and use the rst order condition to nd b i (vi ):
2 n1 i (n 1)nn1 bn vi nn bi i = =0 bi (n 1)n1 n1

so (n 1)vi nbi = 0 (n 1)vi b . i (vi ) = n

All-Pay Auctions
a. If player 1 has a pure strategy of bidding b1 < 100, player 2 will want to bid b1 + . Player 2 then makes prots 2 = 100 b1 > 0. This is sort of like Bertrand duopoly in reverse. With Bertrand duopoly the rms can bring prices down to pi = c. Here if the players were to bid 100, they would each expect to lose 50, so that cannot be an equilibrium.

b. We test for whether the uniform bidding distribution is an equilibrium using the same methods we use for mixed strategies (since it is a mixed strategy. . . ). That is, if player 1 is randomizing her bid b1 from 0 to 100, are bids b2 from 0 to 100 optimal for player 2? Player 2 has utility U2 (b2 ) = Pr(b2 > b1 ) 100 b2 = b2 100 b2 = 0 100

for any b2 . Bidding 10 costs 10 and wins the object 1/10 of the time, which gives the same expected utility as bidding 50, which costs 50 but wins the object 1/2 of the time. Any b2 2

from 0 to 100 is a best response to the randomization of player 1. Likewise, all of player 1s bids will be a best response if player 2 randomizes uniformly. Both players randomly bidding from 0 to 100 is a Nash equilibrium.

c. There is a non-symmetric equilibrium in which one player bids bi = 100 and the other player bids bi = 0. Both players have no incentive to deviate.

Double Auctions
Consider the following potential equilibrium: ps (vs = 0) = pb (vb = 1) = 1/2 and ps (vs = 3) = pb (vb = 4) = 7/2. We must check that these prices maximize utility for each type conditional on what the other roles types ask or demand.

Low value seller: vs = 0 sellers get utility us (p, vs = 0) = Pr(p < pb ) (p 0) For ps less than the lowest buyer price, Pr(ps 0 Pr(p < pb ) = 3/5 1 < pb ) = 1. More generally, if p > 7/2 if 1/2 > p 7/2 . if p 1/2

Using this, us (p, vs = 0) = Pr(p < pb ) p is if p > 7/2 0 us = (3p)/5 if 1/2 > p 7/2 . p if p 1/2 Hence the low value sellers can do better asking for p = 7/2, which generates expected utility 21/10 than p = 1/2, which generates expected utility 1/2 (note that this holds true for any p 1, i.e., any p the low value buyers are willing to pay. This suggests that the following set of strategies may be an equilibrium: pb (vb = 1) = 1/2 and ps (vs = 0) = ps (vs = 3) = pb (vb = 4) = 7/2. Under these new strategies, clearly the high value seller is maximizing utility and we have just established that the low value seller is maximizing utility. What about the buyers?

Low value buyer: vb = 1 buyers cannot get the object at less than p = 7/2 > vb = 1 so they will never purchase.

High value buyer: vb = 4 buyers get utility ub (p, vb = 4) = Pr(p ps ) (4 p) which is 0 if p < 7/2 ub = 4 p if p 7/2 The maximum of this function is p = 7/2, so high value buyers offering p = 7/2 is an equilibrium.