ECON 440/640 Problem Set 3 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

Procurement Auctions
Each rm has expected prot i = Pr(bi < bj )(bi ci ). If there is a linear bidding equilibrium where bj = + cj , then Pr(bi < bj ) = Pr(bi < + cj ) = Pr(cj > (bi )/ ) = 1 Pr(cj < (bi )/ ) bi =1 + bi = . Substituting this expression into the prot expression gives i = + bi 2 (bi ci ).

Optimal bidding for i as a function of his type is given by the rst order condition di + bi bi c i =0= , dbi so + bi bi + ci = 0 + + ci bi = . 2 bi also equals + ci , giving us a second equation for the two unknowns and . Clearly = 1/2, so + 1/2 + ci ci =+ 2 2 /2 + 1/4 = = 1/2. We have worked out that the bidding strategy bA = 0.5 + 0.5cA is a best response to bB = 0.5 + 0.5cB and vice-versa, so these linear bidding strategies are a Bayesian Nash equilibrium. What is the cost to Harrysville? E [c] = min{cA , cB }
1 t 1

=
0 1 0

t+
t =1 [xt]t t=x 0 1

t dx dt
t=x

= =
0

t2 + 2

dx
t=0

x2 dx 2
x=1 x=0

x2 x3 = 2 6 1 = 3 and the expected winning bid is E [b] =

1 1/3 2 + = . 2 2 3

All-Pay Auctions
a. If player 1 has a pure strategy of bidding b1 , player 2 will want to bid b1 + . 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 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.