Koç University

Name:

ECON (MGEC) 333

Game Theory and Strategy
Final Examination Solutions

Levent Koçkesen December 9, 2005

Instructions

Please write your name in the space provided at the top.

Answer all questions.

Write your answers in the space provided for each answer.

Show enough of your work so that we can follow your logic.

Please do not share this exam with anybody outside this class.

Time allowed: 120 minutes.

Max You get

Question 1 25 pts
Question 2 25 pts
Question 3 25 pts
Question 3 25 pts
Total 100 pts

Good Luck!

1
1. A robber (R) has seen a potential victim and is trying to decide whether to attack (A) or pass
(P ). If he attacks, then the victim (V ) has to decide whether to Fight (F ) or yield (Y ). If he
does not attack then both the robber and the victim receive a payo¤ of zero. If he attacks and
the victim yields the robber gets v dollars from the victim; if she resists, however, the robber
can get only v=2 dollars and both pay the cost of …ght, which we assume to be equivalent to c
dollars. [Assume that c > v=2 > 0]. Therefore, we have the following extensive form game.

Rb
@
P @A
@
r @Vr
@
0; 0 @
F @Y
@
r @r
@
v=2 c; v=2 c v; v

Figure 1: Robbery Game

(a) Find the backward induction equilibria of this game:

(A; Y )
(b) Find the pure strategy Nash equilibria of the game.
Strategic form of the game is given by

F Y
A v=2 c; v=2 c v; v
P 0;0 0;0

Set of pure strategy Nash equilibria = f(P; F ); (A; Y )g

2
2. Consider the repeated version of the extensive form game in Question 1 with discount factor
2 (0; 1) for each player.

(a) Find the backward induction equilibria of the …nitely repeated version.
Let the game be repeated for n times. In the nth stage victim plays Y and robber plays A.
Given that in the (n 1)th stage the equilibrium play is (A; Y ) again. Continuing in this
fashion we …nd that the unique backward induction equilibrium is (A; Y ) in every stage.
(b) Consider the in…nitely repeated version and determine the conditions under which, if any,
the following strategies constitute a subgame perfect equilibrium:
Robber :
Start with Pass (P )
Attack if there is any outcome (A; Y ) in the past [that is the robber attacked and the
victim yielded]
Pass otherwise
Victim: In case an attack occurs
Yield if there is any outcome (A; Y ) in the past
Fight otherwise
Let’s check if the victim’s strategy is optimal after any history. It is enough to check two
types of histories which end with an attack:
(1) There is an outcome (A; Y ) in the history
Playing the strategy yields:

(A; Y ); (A; Y ); (A; Y ) ; : : :

and the corresponding sequence of payo¤s

v; v; v; : : :

One-shot deviation yields:

(A; R) ; (A; Y ) ; (A; Y ) ; : : :

with the corresponding sequence of payo¤s

v=2 c; v; v; : : :

Since v=2 c < v the one-shot deviation is not pro…table. Therefore, the strategy is
optimal after any such history.
(2) There is no (A; Y ) in the history
Playing the strategy yields:

3
 (A; R); P; P; : : :

and the corresponding sequence of payo¤s

v=2 c; 0; 0; : : :

Normalized discounted sum of these payo¤s is (1 ) ( v=2 c)

One-shot deviation yields:

(A; Y ) ; (A; Y ) ; (A; Y ) ; : : :

with the corresponding sequence of payo¤s

v; v; v; : : :

Normalized discounted sum of these payo¤s is v: For the one-shot deviation to be not
pro…table we need
(1 ) ( v=2 c) v

or
c 12 v
c + 12 v
Therefore, if satis…es this condition the strategy is optimal after any such history.
Let’s now check if the robber’s strategy is optimal after any history. Again, it is enough
to check two types of histories:
(1) There is an outcome (A; Y ) in the history
Playing the strategy yields:

(A; Y ); (A; Y ); (A; Y ) ; : : :

and the corresponding sequence of payo¤s

v; v; v; : : :

One-shot deviation yields:

P; (A; Y ) ; (A; Y ) ; : : :

with the corresponding sequence of payo¤s

0; v; v; : : :

Since v > 0; the one-shot deviation is not pro…table. Therefore, the strategy is optimal
after any such history.

4
(2) There is no (A; Y ) in the history
Playing the strategy yields:

P; P; P; : : :

and the corresponding sequence of payo¤s

0; 0; 0; : : :

One-shot deviation yields:

(A; R) ; P; P; : : :

with the corresponding sequence of payo¤s

v=2 c; 0; 0; : : :

Since c > v=2; the one-shot deviation is not pro…table. Therefore, the strategy is optimal
after any such history.
Therefore, the strategies constitute a subgame perfect equilibrium if and only if

c 12 v
c + 12 v

5
3. A child has $100 and can save any portion of it. The parent of the child, who has $50, observes
how much the child saves and decides how much of his $50 to leave for the child as bequest. If
the child saves s dollars and the parent’s bequest is b dollars the payo¤s of the child and the
parent are given as follows:

uC (s; b) = ln (100 s) + ln (s + b)
uP (s; b) = ln (50 b) + uC (s; b)

Find the subgame perfect equilibria of this game.

Math reminder: For any di¤erentiable function f (x)

d ln [f (x)] f 0 (x)
=
dx f (x)

Let’s start with solving the parent’s problem:

max fln (50 b) + ln (100 s) + ln (s + b)g

0 b 50

First order condition is

@ 1 1
(ln (50 b) + ln (100 s) + ln (s + b)) = + =0
@b 50 b s+b
which is solved as
1
b = 25s
2
Since the …rst derivative is decreasing in b second order condition is also satis…ed. Therefore,
the parent’s subgame perfect equilibrium strategy is given by
(
25 12 s; s 50
b (s) =
0; s > 50

Let’s …rst assume that equilibrium savings s 50. Then, we must have

1
s 2 arg max ln (100 s) + ln s + 25 s
0 s 100 2

First order condition is

@ 1 1 1
ln (100 s) + ln s + 25 s = + =0
@s 2 s + 50 s 100

which is solved as s = 25: [Since the …rst derivative is decreasing in s second order condition
is also satis…ed.]
This would lead the parent to choose b = 12:5: The resulting payo¤ of the child is

ln (75) + ln (37:5) = ln (75 37:5) = ln (2812:5)

6
If s > 50; then the payo¤ of the child is given by

ln (100 s) + ln (s) = ln [(100 s) s] < ln (2500) < ln (2812:5)

Therefore, the optimal strategy of the child is s = 25 and the unique subgame perfect equi-
librium is given by

s = 25
(
1
25 2 s; s 50
b (s) =
0; s > 50

7
4. Consider the strategic form game between a robber and a victim. Victim is either weak or
strong and the payo¤ matrices (where robber is the row player and victim is column player)
corresponding to the two types are given as follows:

F Y F Y
A 1; 3 2; 2 A 1; 1 2; 2
P 0; 1 0; 0 P 0; 1 0; 0
Weak (1 q) Strong (q)

Robber does not know the type of the victim but believes that she is strong with probability
q 2 (0; 1) : Find the set of pure strategy Bayesian equilibria of this game as a function of q:
Notice that F is a strictly dominant strategy for the strong type. Therefore, we may have two
possible equilibrium con…gurations:
(1) Strong plays F; Weak plays F
Robber’s best response to these strategies is P: Weak victim’s best response to that is F and
therefore the following is a Bayesian equilibrium independent of q :
Strong Weak
P; F ; F

(2) Strong plays F; Weak plays Y

Expected payo¤ of the robber from playing A is given by

(1 q) 2+q ( 1) = 2 3q

whereas the expected payo¤ to P is zero. For the weak victim to play Y robber must be playing
A which implies that
2 3q 0

or
2
q
3
If this holds the following is another Bayesian equilibrium:
Strong Weak
A; F ; Y

In sum, if q > 2=3 unique Bayesian equilibrium is given by

Strong Weak
P; F ; F

and if q 2=3 there is another Bayesian equilibrium

Strong Weak
A; F ; Y