SVKM’s NMIMS

School of Business Management

Programme: FTMBA – II yr Trimester VI Year: 2020-21
Course: Game Theory and its application Date:
Marks: 40
Time: 2 hrs.
Final Examination (2020 – 2021 batch)
Answer all questions
1) Two animals are fighting over some prey. Each can be passive or aggressive. Each prefers to
be aggressive if its opponent is passive, and passive if its opponent is aggressive, given its own
stance, it prefers the outcome in which its opponent is passive to that in which its opponent is
aggressive. Formulate this situation as a strategic game and find its Nash equilibria.
(4 marks)

“ The animals’ preferences are as follows: “

 “Each animal prefers to be aggressive (rather than passive) if its opponent is passive. “
 “Each animal prefers to be passive (rather than aggressive) if its opponent is aggressive. “
 “Taking its own choice as given, each animal prefers the outcome where its opponent
chooses passive, rather than aggressive. “

“Formulate this situation as a strategic game. Give a 2x2 payoff matrix that represents this
situation, and find the Nash equilibria. “

“Suppose each player has two actions, P (for passive) and A (for aggressive). Consider the four
outcomes (A, A), (A, P ), (P, A) and (P, P ) from the point of view of Player 1. “

 “Each animal prefers to be aggressive (rather than passive) if its opponent is passive:
therefore, (A, P ) > (P, P ). “
 “Each animal prefers to be passive (rather than aggressive) if its opponent is aggressive:
therefore, (P, A) > (A, A). “
 “Taking its own choice as given, each animal prefers the outcome where its opponent
chooses passive, rather than aggressive: therefore, (A, P ) > (A, A) and (P, P ) > (P, A). “

“Combining these relations, we get (A, P ) > (P, P ) > (P, A) > (A, A). Player 2’s actions are symmetric,
so Player 2’s ranking of outcomes is (P, A) > (P, P ) > (A, P ) > (A, A). Assigning the payoffs 3, 2, 1, 0 to
these outcomes, we get the matrix “

A P
A 0,0 3,1
P 1,3 2,2

“The set of Nash equilibria is (P, A) and (A, P ). “

 2) Player I prefers B to S and player 2 prefers S to B. Player I is unsure whether player 2 prefers
to go out with him or prefers to avoid him, whereas player 2, knows player 1’s preferences.
Player 1 thinks that with probability ½ player2 wants to go out with him, and with probability
½ player 2 wants to avoid him. The pay-off tables for each different types of player 2 are
given below:

Player 2 Player 2
B S B S
3 2 0 0 B 3 0 0 3
Player B Player S 0 2 2 0
1 0 0 2 3 1
S

Player 2 likes 1 Player 2 does not like 1

Show player 1’s pay-off table, player 2’s pay-off table. Find the Bayesian Nash equilibrium.
(4 marks)

“We can think of there being two states (of Nature), one in which payoffs are given in the left table
and one in which payoffs are given in the right table. Player 2 knows the state (she knows whether
she wishes to meet or to avoid player 1) whereas player 1 does not know; player 1 assigns probability
1⁄2 to each state. “

“The notion of Nash equilibrium for a strategic game models a steady state in which each player’s
beliefs about the other players’ actions are correct, and each player acts optimally, given her beliefs.
We want to generalize this notion to the current situation. “

“From player 1’s point of view, player 2 has two possible types, one whose preferences are given in
the left table and one whose preferences are given in the right table. Player 1 does not know player
2’s type, so to choose an action rationally she needs to form a belief about the action of each type.
Given these beliefs and her belief about the likelihood of each type, she can calculate her expected
payoff of each of her actions. We next calculate the expected payoff of each one of player 1’s actions
corresponding to each combination of actions of the two types of player 2. “

(B,B) (B,S) (S,B) (S,S)

B 3 3/2 3/2 0
S 0 1 1 2
“For this situation, we define a pure strategy Nash equilibrium to be a triple of actions, one for player
1 and one for each type of player 2, with the property that - the action of player 1 is optimal, given
the actions of the two types of player 2 (and player 1’s belief about the state). “

“- the action of each type of player 2 is optimal, given the action of player 1. “

“Now we obtain best responses of player 1 (against the possible actions of the two types of player 2)
and best responses of each type of player 2 (against the actions of player 1). “

(B,B) (B,S) (S,B) (S,S)

B 3 3/2 3/2 0
S 0 1 1 2

B S
B (,2) (,0)
S (,0) (,3)

Above case refers to P2 wishes to meet P1

B S
B (,0) (,3)
S (,2) (,0)

Above case refers to P2 wishes to avoid P1

“It is easy to show that (B, (B, S)), where the first component is the action of player 1 and the other
component is the pair of actions of the two types of player 2, is a Nash equilibrium. “

“Given that the actions of the two types of player 2 are (B, S), player 1’s action B is optimal (that is, it
maximizes her expected payoff); given that player 1 chooses B, B is optimal for the type who wishes
to meet player 1 and S is optimal for the type who wishes to avoid player 1. “

“We can interpret the actions of the two types of player 2 to reflect player2’s intentions in the
hypothetical situation before she knows the state. We can tell the following story. Initially player 2
does not know the state: she is informed of the state by a signal that depends on the state. Before
receiving this signal, she plans an action for each possible signal. After receiving the signal, she carries
out her planned action for hat signal. We can tell a similar story for player 1. To be consistent with
her not knowing the state when she takes an action, her signal must be uninformative; it must be the
same in each state. Given her signal, she is unsure of the state; when choosing an action she takes
into account her belief about the likelihood of each state given her signal. “

3) Explain why a pure Non-linear incentive scheme for the employees is inappropriate in the
corporate sector? Also elaborate why a mix of Non-linear and linear incentive schemes are
more appropriate. (16
marks)

4) What are the different kinds of auctions? Elaborate. Also explain Revenue equivalence and
the rationale behind the same (16 marks)

“In an auction, commodity is floated for Sale and bids are invited from the potential buyers, subject
to a reservation price for the seller. There would be a stipulated period of time. After the auction
ends the commodity would be sold to the highest bidder. “
“In a posted price, A commodity is floated for sale and a price tag is attached. The commodity would
be sold to the person who is ready to pay the price. It is a take it or leave it situation. ”

“The Auction we mentioned is a monopoly kind of thing with one seller and many potential buyers.
The highest bidder wins. ”

“It is a monopsony kind of thing with one buyer and many suppliers. Suppliers are submitting their
bids simultaneously. The lowest bidder wins and sells the commodity to the buyer. ”

“Example- GENCOs are generating power and selling power to the DISCOM. ”

“The different kinds of auctions are: ”

1) English Auction

2) Japanese Auction

3) Vickrey Auction

4) Dutch Auction

5) Buy it now Auction ( this is seen in eBay)

English Auction:

“There are couple of people present in the room. A commodity will be floated and bids will be invited
from the bidders. They will bid orally one by one. The highest bidder will win and get the commodity
and pays his bid. ”

“Bidding Interval: Bidding interval can be 5 or 10. If it is 5 then the successive bids will be like:
90,95,100 …If it is 10 then the successive bids will be like: 90,100,110 …. ”

“Value of a bidder– Value of a bidder is his/her walkaway number eg. If the maximum amount I am
willing to pay is $92 my walkaway number would be $90, when the bidding interval is 5. ”

“If you are a bidder in the English Auction set up you see how others are bidding. But there is high
possibility of Jump bid (It happens especially when there are no bidding interval) ”

Hence there may be lack of transparency.

Japanese Auction

“Every participant will have to keep their hands up in the beginning. There would be an ascending
clock. You put your hand down when the number in the clock exceeds your walkaway number. ”

Vickrey Auction
“Bidders are submitting their bids in sealed envelope simultaneously. The envelopes will be opened.
The highest bidder wins and pays the 2 nd highest bid. Every bidder has a dominant strategy- Bidding
true value ”

Dutch Auction

“It is a descending Auction. Ex: Flowers are sold in Holland. ”

Buy it now Auction

“Typically in eBay. Ex: A beautiful Yacht is displayed. A price tag of $3000 is attached “or Best offer”
is mentioned. “

Revenue Equivalence & Rationale:

“Different Auction mechanism would give more or less same revenue to the seller. This has been
explained in detail below: “

Buyers premium:

“The Auction house like SOTHBEY takes 20% commission from the buyer. If the maximum amount of
money you are willing to pay for a commodity X is $120. Then your maximum bid should be$100. “

Winners Curse

“Sometime you win the auction. After winning you may feel that you have overpaid. This happens
only in first price auction. “

Online Auction in eBay and the use of proxy bid.

“eBay adheres to 2nd price Auction. The commodity you want to buy has substitutes. How will you
allocate your bid? My total budget for a Guitar is $400. But many Guitars are floated by different
sellers in eBay. This is situation created in eBay auction “

“Astute bidders do not bid their true proxy bid in the beginning. They bid it just before the auction
ends. This is known as SNIPING. “

“Ex: In eBay a typical Auction continues for 7 days. So If you bid your true value at the beginning
other bidders would get an idea about the real worth of the commodity. They may bid high. Most of
the bidders are lazy. They bid casually without knowing too much about the commodity. If you bid
high in the beginning, they may start working hard to gather information on the commodity,
eventually that would make them bid a higher value. And you do not want that. “

“For consumer goods, Auction is becoming relatively unpopular. “

“Research shows that rich people are impatient and they prefer posted price option. There are
negative outcome bias. You want to acquire a company X without knowing the real resale value of
the company. But whatever the real worth of the company is, you are sure that you can add 50% to
its worth, before reselling. You know the real worth of the company is lying between $2 billion- $12
billion. All values between $2 billion- $12 billion are equally likely. “

First priced sealed bid auction

“Bidders are simultaneously submitting their bids in sealed envelopes. The envelopes are opened
simultaneously. The highest bidder wins and pays the bid. If your true value is 100 you should shade
down your value closest to the 2 nd highest bid( which you think the 2 nd highest bid would be ). May be
81. “

When the bids are uniformly distributed:

“The value of the bids are lying between 0-100 with equal probabilities. Your true value is 80 and
there is one other bidder. Your bid should be 41. Your true value is 80 and there are two more
bidders. Your bid should be little more than 53.Your true value is 80 and there are 3 more bidders.
Your bid should be 61. “

Uniform procurement Auction

“The lowest K bids would be the winning bids. Each winner would be paid equal to (K+1) th bid. “
Differentiating procurement Auction
“The lowest K bids would be the winning bid and each winner would be paid their bid. “