Question 1 [10 marks]

Consider the stage game represented below:

½ A B C D
A 6,6 0,0 0,0 0,8
B 0,0 1,5 0,0 0,0
C 0,0 0,0 5,1 0,0
D 8,0 0,0 0,0 4,4

a. Suppose this game is played twice. Construct a subgame perfect strategy where A, A is
played in the first round
b. Suppose the game is played for three rounds. Is it possible to construct a subgame perfect
strategy where D, A is played in one of the rounds?

Question 2 (20 marks)

a. Stage Game
1\2 A B
A 2,1 -1,4
B 3,-3 0,0

Suppose that both players follow the following grim-trigger strategy: Play A as long as
no one has ever played B. Otherwise play B. Find the minimum value of the discount
factor delta such that this is a subgame-perfect equilibrium. [6 marks]

b. Is it possible to construct a forgiving trigger strategy instead of a grim trigger strategy in

part a. If the length of punishment is 1 round, will the forgiving trigger be subgame
perfect with a delta = 0.5 for both players.[ 7 marks]

Question 3 [10 marks]

Two players are trying to divide 100 dollars amongst themselves. In period 1, player 1 makes an
offer to player 2. If player 2 accepts this offer, the game ends and they both get payoffs as
suggested by player 1’s division. If player 2 rejects player 1’s offer, the game moves to period 2.
In period 2, player 2 makes an offer which player 1 can accept or reject. If player 1 accepts
player 2’s offer, they each get to keep an amount as suggested by player 2’s division. If Player 1
rejects player 2’s offer, the game moves to the final round. In this round player 1 makes an offer
which can either be accepted or rejected by player 2. Rejection leaves each player with nothing.
If player 2 accepts, they each get payoffs as suggested by player 1’s division.
Here are some additional guidelines. There is no discounting or costs. However, some money is
taken away from the players at the start of the 2nd and 3rd rounds. In particular, the players have
2/3rd of the original amount (100 dollars) with them to bargain over at the start of round 2. At the
start of round 3, they only have available, 1/3rd of the amount they had in period 1. The rest of
the amounts are donated to charity by a third party as punishment that these players are taking
too long to come up with an agreement.
Solve for all subgame perfect Nash equilibria for this bargaining game.

Question 4 [10 marks]

Two players are bargaining over a three period bargaining model as discussed in class with
player 1 making offers in rounds 1 and 3. Player 2 makes an offer in round 2 only. Each player
has a common discount factor delta.
The two players are bargaining to split $20. They have three time periods available to them for
their bargaining game. At the end of round 3, if no agreement has been reached then player 1
receives $2 and player 2 receives $1 and the rest of the money is destroyed.
Find the subgame perfect Nash equilibrium outcome in the finite horizon model in which the
game ends after period 3.