ECON 487 Game Theory S.

Mialon

I. “Mysterious Howling”
Consider the following extensive form game:
Three players, Penelope, Fredrick, and Alexander (The Incorrigible), are playing the following
game. Alexander (The Incorrigible), deserted in a forest at early age, had been raised by a
wolf, but was recently found by Fredrick. Naturally, Alexander has a habit of howling from
time to time. Fredrick hired Penelope to teach Alexander to behave like a civilized person.
Fredrick believes that Alexander will receive a great attention from his friends who are
interested in conducting scientific studies about Alexander’s case. So, Frederic is thinking
about inviting Alexander to a Christmas Party, during which he can introduce Alexander to
his friends. However, Frederic is unsure if Alexander is going to behave. If Alexander howls
like a wolf instead, Fredrick will feel humiliated. He does not want to be in that situation.
So, Fredrick consults with Penelope about his plan.

Penelope is a caring governess. She knows that Alexander can be ready for his social debut,
but she does not want to force Alexander to attend the party unless he wants to. Knowing
Alexander, Penelope believes that it is better to leave the invitation letter anonymously on
Alexander’s desk so that Alexander will not know who gave the letter.

The payoffs of both players are given in the figure.

Penelope

Pass
Fredrick
Invite
Invite Not

Alexander (The Incorrigible) Alexander

Accept Accept and Stay home Go

and Prepare Not and silent into the
Prepare Not forest

Penelope : 4 1 5 2 1 3
Fredrick : 4 1 5 2 1 3
Alexander: 4 1 0 2 0 1

1. Find all pure-strategy Nash Equilibria and subgame perfect Nash Equilibria.
2. For Perfect Bayesian Nash Equilibrium (PBE):
• Write out the players’ expected payoffs and their best responses.
• Find all Perfect Bayesian Nash Equilibrium (PBE):

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 ECON 487 Game Theory S. Mialon

II. “Pre-trial Settlement”

In the U.S. most of legal disputes are settled prior to a trial. Only less than 5% of all legal
disputes are resolved by trials. The following describes the interactions between the
plaintiff (the victim) and the defendant (the injurer) of a tort lawsuit in a pre-trial
bargaining and settlement process.

After using an acne treatment drug for a month, Jamie (the plaintiff) started experiencing
many side effects including dizziness, joint pain, and inflammatory bowel diseases (IBD).
Jamie filed a lawsuit against Roche, the manufacturer of the drug for compensation.

While Jamie knows exactly how much of pain and suffering she is going through, Roche
(the defendant) has no way of verifying it, prior to going to trial.
For simplicity, we can consider that Jamie is entitled to either a high damage ward 𝐷𝐷𝐻𝐻 > 0
(for a severe suffering) or a low damage award 𝐷𝐷𝐿𝐿 > 0 (for a less severe suffering).
Suppose that Roche knows that there is a 60% chance that she has a case of high damage,
and 40% chance that she has a case of a low damage. Naturally, 𝐷𝐷𝐻𝐻 > 𝐷𝐷𝐿𝐿 > 0.

Before going to a trial, Jamie can make take-it-or-leave-it offer, requesting either 𝐷𝐷𝐻𝐻 𝑜𝑜𝑜𝑜 𝐷𝐷𝐿𝐿
to settle. Then, Roche either accepts or rejects the offer. If the offer is accepted, the game
ends according to the offer. If the offer is rejected, the case goes to trial.

Roche’s payoffs depend on the offer and whether or not the trial court opens as a result of
rejecting the offer. If Roche accepts the offer, the payoff for Roche is the agreed amount to
pay. If Roche rejects and goes to trial, a long process takes place. The court will find out
the truth about the nature of Jamie’s suffering correctly. If it was a case of high damage, by
the end of the trial Jamie’s suffering will be unbearable, and this would result in double
amount of the rejected offer during the settlement process, i.e., −2𝐷𝐷𝐻𝐻 if 𝐷𝐷𝐻𝐻 was rejected,
𝑜𝑜𝑜𝑜 −2𝐷𝐷𝐿𝐿 if 𝐷𝐷𝐿𝐿 was rejected. However, if it was a case of low damage, Jamie is likely to be
blamed for an equal fraction of responsibility, the damage award Roche has to pay will be
discounted to the half of rejected offer, i.e. -12𝐷𝐷𝐻𝐻 or - 12𝐷𝐷𝐿𝐿 .

For Jamie’s payoffs, let’s assume a simpler payoff structure for simplicity of the analysis.
Regardless of the actual level of damage, if 𝐷𝐷𝐻𝐻 is accepted by Roche, her payoff is 5.
If 𝐷𝐷𝐿𝐿 is accepted, her payoff is 3 when the damage is high, and her payoff is 4 when the
damage is low.
When the case goes to trial, if the damage is high, she gets 1 if she offered 𝐷𝐷𝐻𝐻 in pre-trial
bargaining, while she gets 0 if the offer was lower.
When the case goes to trial, if the damage is low, she gets 3 if she offered 𝐷𝐷𝐻𝐻 in pre-trial
bargaining, while she gets 2 if the offer was lower.

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 ECON 487 Game Theory S. Mialon

Questions:
1. Draw the extensive from representation of the game between Jamie and Roche. All
the elements stated above need to be included in the game.
2. Derive the expected payoff and the best response functions of each player.
3. Is there a separating equilibrium? If so, derive all the separating equilibria. If not,
show why not.
4. Is there a pooling equilibrium? If so, derive all the pooling equilibria. If not, show
why not.