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05/05/2013

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ECON 440/640 Problem Set 4 Answers
Problem 3.3
When
b
i
=
b
L
,
π
i
(
p
i
)
is
π
i
(
p
i
) = (
a
p
i
b
L
[
p
j
])
p
i
so
i
dp
i
=
a
b
L
p
j
2
p
i
p
i
=
p
L
=
a
b
L
[
p
j
]2
.
Likewise when
b
i
=
b
,
p
i
=
p
=
a
b
[
p
j
]2
.
The expected price the other ﬁrm sets is
[
p
j
] =
[
p
] =
θp
+ (1
θ
)
p
L
so
[
p
] =
θ
a
b
L
[
p
]2
+ (1
θ
)
a
b
[
p
]2
[
p
] =
a
2
θb
L
(1
θ
)
b
.
It is possible to use
[
p
]
to solve for
p
and
p
L
, but as far as I can tell, doing so does notlead to anything interesting.
Problem 3.6
The problem asks you to show that in there are
n
bidders, then the strategy of bidding
b
i
=(
n
1)
v
i
/n
is a symmetric BNE. Given that everyone plays this strategy, the probabilityof
b
i
being the winning bid is
Pr(
b
i
>
max
{
b
j
|
j
=
i
}
) = Pr(
b
i
> b
1
)
Pr(
b
i
> b
2
)
...
= Pr(
b
i
>
(
n
1)
v
1
/n
)
Pr(
b
i
>
(
n
1)
v
2
/n
)
...
= Pr(
v
1
< nb
i
/
(
n
1))
Pr(
v
2
< nb
i
/
(
n
1))
...
=
nb
i
n
1
n
1
1

The ﬁrst step follows because for
b
i
to be the maximum bid, it must be greater than eachother bid.Using this result, we can rewrite
π
i
as
π
i
= Pr(
b
i
>
max
{
b
j
|
j
=
i
}
)(
v
i
b
i
)=
nb
i
n
1
n
1
(
v
i
b
i
)=
n
n
1
b
n
1
i
v
i
n
n
1
b
ni
(
n
1)
n
1
and use the ﬁrst order condition to ﬁnd
b
i
(
v
i
)
:
∂π
i
∂b
i
=(
n
1)
n
n
1
b
n
2
i
v
i
n
n
b
n
1
i
(
n
1)
n
1
= 0
so
(
n
1)
v
i
nb
i
= 0
b
i
(
v
i
) =(
n
1)
v
i
n.
All-Pay Auctions
a.
If player 1 has a pure strategy of bidding
b
1
<
100
, player 2 will want to bid
b
1
+
.Player 2 then makes proﬁts
π
2
= 100
b
1
>
0
. This is sort of like Bertrand duopolyin reverse. With Bertrand duopoly the ﬁrms can bring prices down to
p
i
=
c
. Here if theplayersweretobid100, theywouldeachexpecttolose50, sothatcannotbeanequilibrium.
b.
We test for whether the uniform bidding distribution is an equilibrium using the samemethods we use for mixed strategies (since it
is
a mixed strategy...). That is, if player 1 israndomizing her bid
b
1
from 0 to 100, are bids
b
2
from 0 to 100 optimal for player 2?Player 2 has utility
2
(
b
2
) = Pr(
b
2
> b
1
)
100
b
2
=
b
2
100
100
b
2
= 0
for any
b
2
. Bidding 10 costs 10 and wins the object
1
/
10
of the time, which gives the sameexpected utility as bidding 50, which costs 50 but wins the object
1
/
2
of the time. Any
b
2
2

from 0 to 100 is a best response to the randomization of player 1. Likewise, all of player1’s 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
b
i
= 100
and the otherplayer bids
b
i
= 0
. Both players have no incentive to deviate.
Double Auctions
Consider the following potential equilibrium:
p
s
(
v
s
= 0) =
p
b
(
v
b
= 1) = 1
/
2
and
p
s
(
v
s
=3) =
p
b
(
v
b
= 4) = 7
/
2
. We must check that these prices maximize utility for each typeconditional on what the other role’s types ask or demand.
Low value seller:
v
s
= 0
sellers get utility
u
s
(
p, v
s
= 0) = Pr(
p < p
b
)
(
p
0)
For
p
s
less than the lowest buyer price,
Pr(
p
s
< p
b
) = 1
. More generally,
Pr(
p < p
b
) =
0
if
p >
7
/
23
/
5
if
1
/
2
> p
7
/
21
if
p
1
/
2
.
Using this,
u
s
(
p, v
s
= 0) = Pr(
p < p
b
)
p
is
u
s
=
0
if
p >
7
/
2(3
p
)
/
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 expectedutility
21
/
10
than
p
= 1
/
2
, which generates expected utility
1
/
2
(note that this holds truefor 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:
p
b
(
v
b
= 1) = 1
/
2
and
p
s
(
v
s
= 0) =
p
s
(
v
s
= 3) =
p
b
(
v
b
= 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?3