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**1. Eliminating Dominated Strategies
**

Test your knowledge on the following questions.

a) Solve the normal form game in of Fig. 1. by eliminating dominated strategies. Verify that the

resulting solution is a Nash equilibrium of the game.

N C J

N 73,25 57,42 66,32

C 80,26 35,12 32,54

J 28,27 63,31 54,29

Figure 1 Eliminating dominated strategies in a 3 x 3 normal form game.

b) Can a Nash equilibrium to the game in Fig. 2 be found by the iterated elimination of dominated

strategies? If so, describe exactly in what order you delete strategies.

a b c d e

A 63, -1 28, -1 -2, 0 -2, 45 -3, 19

B 32, 1 2, 2 2, 5 33, 0 2, 3

C 54, 1 95, -1 0, 2 4, -1 0, 4

D 1, -33 -3, 43 -1, 39 1, -12 -1, 17

E -22, 0 1, -13 -1, 88 -2, -57 -3, 72

Figure 2 Eliminating dominated strategies in a 5 x 5 normal form game.

2. Second- Price Auction

A single object is to be sold at auction. There are n > 1 bidders, each submitting a single bid,

in secret, to the seller. The value of the object to bidder i is v

i

. The winner of the object is the

highest bidder, but i pays only the next highest bid.

a) Show that ”truth-telling” (i.e., each player i bids v

i

) is a dominant strategy for each player. To

simplify the argument, you can assume, where convenient, that there are no ties.

b) Does your analysis depend on whether or not others tell the truth?

c) What are some reasons that real second-price auctions might not conform to the assumptions

of this model?

3. An Increasing-Bid Auction

A Ming vase is to be sold at auction. There are n bidders, and the value of the vase to bidder

i is v

i

> 0, i = 1, ...., n. The auctioneer begins the bidding at zero, and raises the price at the rate

of $ 1 per second. All bidders who are willing to buy the vase at the stated price put their hands

up simultaneously.This last and highest bidder is the winner of the auction and must buy the vase

for the stated price. Show that this auction has the same optimal strategies and the same outcome

as the Second-Price Auction.

HINT: First show that the only undominated pure strategies for bidder i take the form of

choosing a price p

i

and keeping a hand up until the auctioneer’s price goes higher than this. Then

ﬁnd the optimal p

i

.

1

4. Eliminating Dominated Strategies adAbsurdum

Consider an n-player game in which each player announces simultaneously an integer between

1 and 1000. The winner is the player whose announcement is closed to 1/2 of the average of all

the announcements. In the case of a tie, the price is given by a random draw among the winners.

a) Show that if players iterate the elimination of dominated strategies, the only remaining strategy

is to announce 1.

b) To most people, this does not sound like what would actually happen if n people play this game,

probably because people do, at most, a few iterations of dominated strategies. How many levels

of iteration do you think people actually engage in?

c) Extra credit: Stage the game with some friends, with the payoﬀ such that the winner receives

$10.00. Can you estimate how many stage of elimination dominated strategies people will go

through?

5. A Pure Coordination Game

Three people independently choose an integer between two and nine. If the three choices are

the same, each person receives the amount chosen. Otherwise each person loses the amount the

person chose.

a) What are the pure strategy Nash equilibria of this game?

b) How do you think people will actually play this game?

c) What doses the game look like if you allow communication among the players before they make

their choices? How would you model such communication, and how do you think communication

would change the behavior of the players?

6.Variations on Duopoly

In a certain market there are two ﬁrms, which we label a and b. If the ﬁrms produce output

q

a

and q

b

, then the price they will receive for their goods is given by p = α − β(q

a

+ q

b

) or zero

if p would otherwise be negative. Each ﬁrm has marginal cost c > 0 and no ﬁxed costs. Suppose

α > 3c (youll see why we make this assumption as you go through the problem.)

a) Suppose the ﬁrm choose the quantity q

a

and q

b

independently in each period, without regard

to their behavior in previous periods, and each maximizes proﬁts Π

a

= (p − c)q

a

and Π

b

=

(p − c)q

b

.Find the unique pure strategy Nash equilibrium to this game. This is called the

CournotDuopoly model.

b) Suppose the two ﬁrms collude by agreeing that each will produce an amount q

∗

= q

a

= q

b

,

and they have some way to enforce the agreement. What should they choose for q

∗

? What

are the proﬁts of the two ﬁrms? Compare this with the Cournot duopoly proﬁts. This Nash

equilibrium is called the Monopolymodel or the Cartelmodel.

c) Suppose ﬁrm a reneges on its promise on the previous part but b doses not. What should a

choose for q

a

? What are a’s proﬁts, and what are b’s proﬁts?

d) Suppose ﬁrm b ﬁnds out that ﬁrm a is going to do in the previous part, and chooses q

b

to

maximize proﬁts, given what ﬁrm a is going to do. What is q

b

now? What do you think

happens if they go back and forth this way forever?

2

e) Suppose the two ﬁrms choose price as opposed to quantity, where costumers all go to the lowest-

price ﬁrm, and the ﬁrm split the market if they choose the same price. What is the unique Nash

equilibrium of this game? This is called the Bertrandduodolymodel. Bertand’s result is often

called a ”paradox”. In what sense do you think this is an accurate description of this solution?

How do you explain the dramatic diﬀerence in outcomes between this and the Cournot model?

f) Suppose ﬁrm a gets to choose its output ﬁrst and only afterwards doses ﬁrm b get to choose its

output. Find the equilibrium choices of q

a

and q

b

in this case, and compare the proﬁts of the

two ﬁrms with the Cournot duopoly case. This is called the Stackelbergduopolymodel. HINT:

Firm a should ﬁnd its proﬁt for every q

a

, given that ﬁrm b will choose q

b

to maximize its proﬁts

given q

a

. Then, among all these proﬁts, ﬁrm a choose q

a

to maximize proﬁts.

7. The Rotten Kid Theorem

This problem is core of Gary Becker’s (1981) famous theory of the family. You might check the

original, through, since I’m not sure I got the genders right.

1

A certain family consists of a mother and a son, with increasing, concave utility funktions u(y)

for the mother and v(z) for the sun. The sun can aﬀect both his income and of the mother by

choosing a level of familial work commitment a, so y = y(a) and z = z(a). The mother, however,

feels a degree of altruism α > 0 towards the son, so given y and z, she transfers an amount t to

the son to maximize the objective function.

u(y −t) + αv(z + t) (1)

The son, however is perfectly selﬁsh (”rotten”), and chooses the level of a to maximize his own

utility v(z(a) + t). However he knows that his mother’s transfer depends on y and z, and hence

on a.

a) Use backward induction to show, what the son chooses a to maximize total family income

y(a) + z(a).

b) Show that t is an increasing function of α. Also if we write y = y(a) + ˆ y, and t is an increasing

function of the mother’s exogenous wealth ˆ y.

c) Show that for suﬃciently small α > 0, t < 0; i.e., the transfer is from the son to the mother.

HINT: For each a, the mother observes y(a) and z(a), and chooses t = t(a) to maximize (1).

This gives the ﬁrst-order condition −u

+αv

**= 0.Diﬀerentiate the ﬁrst-order condition with respect
**

to a to show that the solution to the ﬁrst-order condition for the maximization of z(a) + t(a) is

the same as for the maximization of y(a) + z(a) = 0.

1

The Rotten Kid Theorem has been empirically tested and receives some support, through

the evidence falls short (often way short) of conﬁrming that cross-generational families maximize

joint income. See Cox 1987, 1990; Cox and Rank 1992; and Altonji et al. 1992, 1997.

3

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