Economics 440/640 Problem Set 4 Due 4/25/2012 You are allowed to work in groups of up to four people.

Only one problem set copy needs to be turned in per group. If you have any questions please email me or stop by my office.

Gibbons Questions
• 3.3 • 3.6

For 3.6, the following result in probability theory can be useful: Pr(bi > max{bj |j = i}) = Pr(bi > b1 ) ∗ Pr(bi > b2 ) ∗ . . . In other words, the probability that bi is highest is the probability that it is higher than every other bid, which is the product of the probabilities that it is higher than each bid.

Additional question
Question 1. All-Pay Auctions. Consider an auction in which all bidders pay their bid, with only the highest bidder winning the auction. This type of auction is an “all-pay” auction. Assume there are two bidders who would each get a value of 100 from owning the object. They simultaneously submit bids bi .

A) Argue that there is no equilibrium in which either player uses a pure strategy where bi < 100. B) Is the following a Nash equilibrium? Each bidder bids a random number between 0 and 100 (i.e., bi is distributed Uniform[0, 100]). C) Find an equilibrium of the game that is different than part B.

Question 2. Double Auction.
A buyer and a seller are considering trading an object. The value of the object to the buyer is 1 with probability 2/5 vb = 4 with probability 3/5


which is known only to the buyer, and the value of the object to the seller is vs = 0 with probability 5/9 3 with probability 4/9

They decide whether to trade by simultaneously naming prices pB and pS . If pB > pS , they exchange the good at the average price named, while if pB < pS , they do not exchange the good. Find an equilibrium of this game.


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