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05/05/2013

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# ECON 440/640 Problem Set 3 Answers

Problem 3.3
When bi = bL , πi (pi ) is πi (pi ) = (a − pi − bL E [pj ])pi so dπi = 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 ﬁrm sets is
∗ E [pj ] = E [p] = θp∗ H + (1 − θ )pL

so E [p] = θ a − bL E [ p ] + (1 − θ) 2 a . E [p] = 2 − θbL − (1 − θ)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 n−1
n−1

1

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

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

Procurement Auctions
Each ﬁrm has expected proﬁt πi = Pr(bi < bj )(bi − ci ). If there is a linear bidding equilibrium where bj = α + βcj , then Pr(bi < bj ) = Pr(bi < α + βcj ) = Pr(cj > (bi − α)/β ) = 1 − Pr(cj < (bi − α)/β ) bi − α =1− β β + α − bi = . β Substituting this expression into the proﬁt expression gives πi = β + α − bi β 2 (bi − ci ).

Optimal bidding for i as a function of his type is given by the ﬁrst order condition dπi β + α − bi bi − c i =0= − , dbi β β so β + α − bi − bi + ci = 0 β + α + ci bi = . 2 bi also equals α + βci , giving us a second equation for the two unknowns α and β . Clearly β = 1/2, so α + 1/2 + ci ci =α+ 2 2 α/2 + 1/4 = α α = 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

x−

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

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 ﬁrms 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 1’s bids will be a best response if player 2 randomizes uniformly. Both players randomly bidding from 0 to 100 is a Nash equilibrium.

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