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# Assignment 2

## 1) Consider the following extensive form game

a) Enlist the strategies for player 1 and player 2. Find backward induction equilibrium and Equilibrium strategies. b) Represent the game in Normal Form Representation c) Find out the Nash Equlibria in the Normal Form d) Find the subgame perfect Nash Equilibrium (6 marks) 2) You have to decide whether to invest \$100 in a friends enterprise, where in a years time the money will increase to \$130. You have agreed that your friend will then repay to you \$120, keeping \$10 to himself. But instead he may choose to run away with the whole \$130. Any of your money what you dont invest In your friends venture you can invest safely at the prevailing interest rate r, and get \$100(1+r) next year. a) Draw the game tree for this situation and show the backward induction outcome. Next suppose this game is played repeatedly infinitely often. That is, each year you have the opportunity to invest another \$100 in your friends enterprise, and the agreement is to split the resulting \$130 in the manner already described. From the second year onward, you get to make your decision of whether to invest with your friend in the light of whether he made the agreement repayment the preceding year. The rate of interest between any two successive periods is r, the same as the outside rate of interest and the same for you and your friend.

(2)

a) For what values of r can there be an equilibrium outcome of the repeated game, which each period you invest with your friend and he repays as agreed? b) If the rate of interest is 10% per year, can there be an alternative profit splitting agreement that is an equilibrium outcome of the infinitely repeated game, where each period you invest with your friend and he repays as agreed. (6 marks) (a) The Benchmark Model: There are three sellers in a homogenous product market. Each seller simultaneously chooses a price from the set {1,2....100}. The prices can take only integer values. The rules for the game are as follows: The seller who announces the lowest price receives a payoff equal to that price and the rest of the sellers earn zero profit. Ties are split equally among the sellers choosing the lowest price. For example, if the announced prices are (4; 4; 10) the third player gets a payoff of zero while the rest two get 2 each. There are no capacity constraints. Solve for all pure strategy Nash Equilibria. (b) Price-Matching Guarantee (PMG) Model: The PMG model has two stages. In stage one, each of the three sellers simultaneously decide whether or not to adopt a PMG. A seller choosing a PMG "has to" match the lowest price chosen in the market. Its assumed that there are no costs to commit to a PMG. In stage two, after observing the first stage decisions by all sellers, sellers simultaneously choose a price from the set {1,2.....100} (only integer values). The total profit in a PMG model will be equal to the lowest price chosen in the market. This profit will be shared equally among the sellers who chose the lowest price directly or indirectly through the PMG. The seller(s) who do not choose the lowest price and do not adopt a PMG will earn zero profit. For example, if all three players commit to the PMG, and announced prices are 33, 42 and 90, then all three players eventually sell at the lowest price of 33 and each earn a profit of 11. There is thus a divergence between posted prices and prices actually offered in the market. a) How many subgames are there starting in stage 2? Solve for all symmetric pure strategy Nash Equilibria (Symmetry implies that all the sellers announce the same price) in each such subgame. b) Is there a dominant strategy in stage 1? Explain. (2 marks) 3) Take any real life situation and explain it using game theory. Preferably using normal form representation and/or a game tree. If there are similar examples the marks will be split between the people submitting the same example. For example, if there are 5 people giving same example with similar explanation each one would get (2/5) marks. Any student giving innovative example can get 2 additional marks on top of 18 marks.