2.

1 Proof: we should show that A maximizes I c ( A) + I p ( A) , this is equivalent to

show I c′ ( A) + I p′ ( A) = 0 .
Solving the game by backward induction:
At stage 2, given I c and I p , parent chooses B to maximize his payoff:

max V ( I p − B) + kU ( I c + B)
B

FOC: kU ′( I c + B) − V ′( I p − B) = 0 *

At stage 1, child chooses A to maximize his payoff:

max U ( I c ( A) + B)
A

∂B
FOC: U ′( I c ( A) + B)i( I c′ ( A) + ) = 0
∂A
From (*), we have:
∂B ∂B ′ ∂B ′
= i I c ( A) + i I p ( A)
∂A ∂I c ∂I p
kU ′′( I c + B) −V ′′( I p − B)
=− i I c′ ( A) − i I p′ ( A)
kU ′′( I c + B ) + V ′′( I p − B ) kU ′′( I c + B) + V ′′( I p − B)
kU ′′( I c + B) V ′′( I p − B)
=− i I c′ ( A) + i I p′ ( A)
kU ′′( I c + B ) + V ′′( I p − B ) kU ′′( I c + B) + V ′′( I p − B)

∂B
U ′( I c ( A) + B)i( I c′ ( A) + )
∂A
− kU ′′( I c + B) V ′′( I p − B)
= U ′( I c ( A) + B)i( I c′ ( A) + i I c′ ( A) + i I p′ ( A))
kU ′′( I c + B) + V ′′( I p − B ) kU ′′( I c + B) + V ′′( I p − B)
V ′′( I p − B)
= U ′( I c ( A) + B)i i( I c′ ( A) + I p′ ( A)) = 0
kU ′′( I c + B) + V ′′( I p − B)

⇒ I c′ ( A) + I p′ ( A) = 0( Since U ′(i) > 0, V ′′(i) < 0 and U ′′(i) < 0)

Another approach:
Solving the game by backward induction:
At stage 2, given I c and I p , parent chooses B to maximize his payoff:

max V ( I p − B) + kU ( I c + B)
B
 FOC: kU ′( I c + B) − V ′( I p − B) = 0 *

At stage 1, child chooses A to maximize his payoff:

max U ( I c ( A) + B)
A

∂B
FOC: U ′( I c ( A) + B)i( I c′ ( A) + ) = 0
∂A
Because U is increasing and strictly concave, so
∂B
U ′( I c ( A) + B) > 0 ⇒ ( I c′ ( A) + ) = 0 （1）
∂A
∂B ∂B
(*) 对 A 求偏导： kU ′′( I c ( A) + B)( I c′ ( A) + ) − V ′′( I p ( A) − B)( I p′ ( A) − ) = 0
∂A ∂A
∂B ∂B
⇒ V ′′( I p ( A) − B )( I ′p ( A) − ) = kU ′′( I c ( A) + B )( I c′ ( A) + ) = 0 (Since (Ic′(A) + ∂B) =0)
∂A ∂A ∂A
∂B
Because V is strictly concave, so V ′′( I p ( A) − B) > 0 ⇒ ( I ′p ( A) − ) = 0 (2)
∂A
(1)+(2) ⇒ I c′ ( A) + I ′p ( A) = 0

2.2 Proof:
At, first, solving the game by backward induction:
At stage 2, given S, parent chooses B to maximize his payoff:
max V ( I p − B) + k (U1 ( I c − S ) + U 2 ( S + B))
B

FOC: −V ′( I p − B ) + kU 2′ ( S + B ) = 0 (*)
At stage 1, child maximizes his payoff:
max U1 ( I c − S ) + U 2 ( S + B)
S

∂B
FOC: −U1′ ( I c − S ) + U 2′ ( S + B)(1 + ) = 0
∂S
From (*), we have
∂B kU 2′′ ( S + B)
=−
∂S V ′′( I p − B) + kU 2′′ ( S + B)

kU 2′′ ( S + B)
−U1′ ( I c − S ) + U 2′ ( S + B )(1 − )
V ′′( I p − B) + kU 2′′ ( S + B)
V ′′( I p − B)
So = −U1′ ( I c − S ) + U 2′ ( S + B )i
V ′′( I p − B) + kU 2′′ ( S + B)
=0

Hence, in the game, child chooses S * such that:

 V ′′( I p − B)
−U1′ ( I c − S * ) + U 2′ ( S * + B)i =0
V ′′( I p − B) + kU 2′′ ( S * + B)

On the other hand, if child chooses S ′ to maximize U1 ( I c − S ) + U 2 ( S + B) ,

where B is exogenous, then S ′ satisfies:

−U1′ ( I c − S ′) + U 2′ ( S ′ + B) = 0

We need to show S * < S ′ .

Denote f ( S ) = −U1′ ( I c − S ) + U 2′ ( S + B), f ′( S ) = U1′′ ( I c − S ) + U 2′′ ( S + B) < 0

f ( S * ) = −U1′ ( I c − S * ) + U 2′ ( S * + B)
V ′′( I p − B) kU 2′′ ( S * + B)
= −U1′ ( I c − S * ) + U 2′ ( S * + B)i + U 2′ ( S * + B)i
V ′′( I p − B) + kU 2′′ ( S * + B) V ′′( I p − B ) + kU 2′′ ( S * + B)

kU 2′′ ( S * + B)
= U 2′ ( S * + B )i
V ′′( I p − B) + kU 2′′ ( S * + B)
> 0 = f ( S ′)

So S * < S ′ . If child save more, i.e. S ′ , both the parent’s and child’s payoffs could be
increased.

2.4 Solving the game by backward induction:

In Period two: given c1 , partner 2 choose c2 , the minimize of c2 to complete

the project is R − c1 .

If V ≥ ( R − c1 ) 2 , c2 = R − c1 , both receive V.

If V < ( R − c1 ) 2 , c2 = 0 , both receive 0.

In Period one: partner 1 choose c1 .

Consider four cases:

(1) if R ≤ (1 − δ )V , that is V − R 2 ≥ δ V , c1 = R , partner 1 will complete the

project himself. So c2 = 0 .

(2) If (1 − δ )V < R ≤ V , that is V − R 2 < δ V and V ≥ R 2 , c1 = 0, c2 = R .

 (3) If (1 + δ ) V ≥ R > V , that is R 2 > V , and ( R − V ) 2 ≤ δ V , the

minimize of c1 to complete the project satisfies: V = ( R − c1 ) 2 , c1 < R , So

c1 = R − V , c2 = V .

(4) If R > (1 + δ ) V , that is ( R − V ) 2 > δ V , it is not worth completing the

project, hence c1 = 0, c2 = 0 .

1
2.7 In the subgame, the equilibrium is qi = Li = (a − w) .
n +1
At stage 1, the union chooses w to maximize its utility:
n
max (a − w)( w − wa )
w n +1
a + wa
FOC: a + wa − 2w = 0 ⇒ w = .
2
n a − wa 2
Then payoffs of the union are ( ) , which is increasing with n. If n
n +1 2
increases, the total output increases, so does the demand for labor, so the union’ utility
increases.

a+c
2.13 Proof: The monopoly price is p = .
2
If the firms use trigger strategies, then if there is no firm deviate, both get
1 a−c 2
i( )
1 a−c 2
i( ) on every stage game, and the total discounted profit is 2 2 .
2 2 1− δ
a−c 2
The payoff from deviating on an stage is ( ) . For the trigger strategies to
2
1 a−c 2
i( )
2 2 a−c 2 1
be SPNE, we must have ≥( ) , that is δ ≥ .
1− δ 2 2
a +c a +c
2.14 The monopoly price is pH = H , pL = L
2 2
If the firms use trigger strategies, and there is no firm deviate, in period with
1 a −c 2 1 a −c 2
1 aH − c 2
δ (π i i( H ) + (1 − π ) i( L ) )
demand aH , the total payoff is i( ) + 2 2 2 2 ,
2 2 1− δ
in period with demand aL , the total discounted payoff is
 1 aH − c 2 1 a −c 2
1 aL − c 2
δ (π i i( ) + (1 − π ) i( L ) )
i( ) + 2 2 2 2 .
2 2 1− δ
aH − c 2
In period with demand aH , payoff from deviating is ( ) ; in period with
2
aL − c 2
demand aL , payoff from deviating is ( ) .
2
For the trigger strategies to be SPNE, we must have
1 a −c 2 1 a −c 2
1 aH − c 2
δ (π i i( H ) + (1 − π ) i( L ) )
a −c 2
i( ) + 2 2 2 2 ≥( H )
2 2 1− δ 2
And
1 a −c 2 1 a −c 2
1 aL − c 2
δ (π i i( H ) + (1 − π ) i( L ) )
a −c 2
i( ) + 2 2 2 2 ≥( L )
2 2 1− δ 2
1 aH − c 2
i( )
⇒δ ≥ 2 2
1 a −c 2 1 a − c 2 1 aH − c 2
(π i i( H ) + (1 − π ) i( L ) ) + i( )
2 2 2 2 2 2
The lowest of δ such that the firms can use trigger strategies to sustain these
monopoly price levels in a SPNE is:
1 aH − c 2
i( )
2 2
1 a −c 2 1 a − c 2 1 aH − c 2
(π i i( H ) + (1 − π ) i( L ) ) + i( )
2 2 2 2 2 2
For each value of δ between 1/2 and δ * , suppose the highest price is p(δ )
when the demand is high.
If the firms use trigger strategies, and there is no firm deviate, in period with
demand aH , the total payoff is

1 1 aL − c 2
1
δ (π i i(aH − p(δ ))( p(δ ) − c) + (1 − π ) i( ) )
i(aH − p (δ ))( p (δ ) − c) + 2 2 2 , in
2 1− δ
period with demand aL , the total discounted payoff is

1 1 aL − c 2
1 aL − c 2
δ (π i i(aH − p (δ ))( p (δ ) − c) + (1 − π ) i( ) )
i( ) + 2 2 2 .
2 2 1− δ
In period with demand aH , payoff from deviating is ( aH − p(δ ))( p(δ ) − c) ; in

aL − c 2
period with demand aL , payoff from deviating is ( ) .
2
For the trigger strategies to be SPNE, we must have
 1 1 aL − c 2
1
δ (π i i(aH − p(δ ))( p(δ ) − c) + (1 − π ) i( ) )
i(aH − p(δ ))( p(δ ) − c) + 2 2 2 ≥ (aH − p(δ ))( p(δ ) − c)
2 1− δ

And
1 1 aL − c 2
1 aL − c 2
δ (π i i(aH − p (δ ))( p (δ ) − c) + (1 − π ) i( ) )
a −c 2
i( ) + 2 2 2 ≥( L )
2 2 1− δ 2
Then we can get the highest price p (δ ) from these two inequalities.

a−c
2.15 The monopoly output is .
2n
If the firms use trigger strategies, when there is no firm deviate, total discounted
a−c 2
(
)
payoff of each firm is : 2 . Given other firms’ equilibrium strategies, payoff
n(1 − δ )

a−c 2 a−c 2
(n + 1)( ) δ( )
from deviating: 2 + n +1 .
n 1− δ
For the trigger strategies to be SPNE, we must have
a−c 2 a−c 2
( )
n +1
δ ( )
2 ≥( (a − c)) +
2 n + 1
n(1 − δ ) 4n 1− δ
(n + 1) 2
⇒δ ≥
(n + 1) 2 + 4n

(n + 1) 2
δ min = , increase with n.
(n + 1) 2 + 4n
If δ is too small, suppose the output of each firm in the most-profitable
symmetric SPNE is q, then the total output is Q=nq.
(a − nq − c)iq
If there is no firm deviate, payoff of each firm is : .
1− δ
a−c 2
a − c − (n − 1)q 2
δ( )
Payoff from deviating: ( ) + n +1
2 1− δ
a−c 2
(a − nq − c)iq a − c − (n − 1)q 2
δ( )
Set =( ) + n +1
1− δ 2 1− δ
a−c a − c (n + 1) 2 − δ (n + 3)(n − 1)
⇒ ≥q≥ i
n +1 n +1 (n + 1) 2 − δ (n − 1) 2
 a − c (n + 1) 2 − δ (n + 3)(n − 1)
qSPNE = i
n +1 (n + 1) 2 − δ (n − 1) 2

2.17 The strategy of the firm: in each period, if observe output y, pays c to the worker,
otherwise, pays nothing.
The strategy of the worker: if the firm has paid in period t-1, expend effort c and
produce output y, otherwise, expend no effort.
y−c
For the firm, payoff from no deviation is:
1− δ
Payoff from deviating is: y
y−c
So a necessary and sufficient condition is ≥ y , that is c ≤ δ y
1− δ

3.2 The strategy spaces for firm 1 is {q1H , q1L }, q1H , q1L ∈ [0, ∞)

The strategy spaces for firm 2 is q2 , q2 ∈ [0, ∞) .

Solving for the Bayesian Nash equilibrium:

t1 = H , π 1H = (aH − q1H − q2 )iq1H − cq1H
For firm 1:
t1 = L, π 1L = (aL − q1L − q2 )iq1L − cq1L

For firm 2: π 2 = θ i(aH − q1H − q2 )iq2 + (1 − θ )(aL − q1L − q2 )iq2 − cq2

FOC:
∂π 1H
= aH − q2 − c − 2q1H = 0
∂q1
H

∂π 1L
= aL − q2 − c − 2q1L = 0
∂q1L

∂π 2
= θ (aH − q1H ) + (1 − θ )(aL − q1L ) − c − 2q2 = 0
∂q2

3−θ 1−θ 1
⇒ q1H = aH − aL − c
6 6 3
2 +θ θ 1
q1L = aL − aH − c
6 6 3
θ 1−θ 1
q2 = a H + aL − c
3 3 3
2 10 L 1 7
Assume aH = 4, aL = 2, θ = , c = 1 , then q1H =
, q1 = , q2 = are all
3 9 3 9
10 1 7
positive. Then the Bayesian Nash equilibrium is q1H = , q1L = , q2 = .
9 3 9
3.4 The strategy spaces for player 1 is {TT,TB,BT,BB}
The strategy spaces for player 2 is {L,R}
The normal form of the game is

L R
TT 1/2,1/2 0,0
TB 1/2,1/2 1,1
BT 0,0 0,0
BB 0,0 1,1
There are three pure-strategy Bayesian Nash equilibria: (TT,L), (TB,R), (BB, R)

4.1 (a) The normal-form game is shown below:

L′ R′
R 2,2 2,2
L 4,1 0,0
M 3,0 0,1
The pure-strategy Nash equilibria: (R, R′ ), (L, L′ ). These are also the SPNE, because
there is no proper subgame.

In the extensive-form game:

So {L, L', p = 1} and {R, R', p < 1/2} are all the perfect Bayesian equilibrium

(b) The normal-form game is shown below

L′ M′ R′
L 1,3 1,2 4,0
M 4,0 0,2 3,3
R 2,4 2,4 2,4
The pure-strategy Nash equilibrium is ( R, M ′)

This is also the SPNE.

L → p = 1 → L′ → M
M → p = 0 → R′ → L
R → p ∈ [0,1]

⎧ L′ : 3 p
⎪
Given p, payoff of player 2 is: ⎨ M ′ : 2 p
⎪ R′ : 3(1 − p )
⎩
 1
p ≤ , R′ is optimal → L
3
1 2
So when ≤ p ≤ , M ′ is optimal → R
3 3
2
p ≥ , L′ is optimal → M
3
1 2
{ R, M ′, ≤ p ≤ } is the perfect Bayesian equilibrium.
3 3

4.2: Proof: If there is pure-strategy perfect Bayesian equilibrium.

u2 ( L′, p ) = 1 − p
Given p:
u2 ( R′, p) = p

If p>1/2, a p = R′ → aR′ = M ⇒ p = 0 . Contradiction

If p<1/2, a p = L′ → aL′ = L ⇒ p = 1 . Contradiction

(Another approach:
L → p = 1 → R′ → M
M → p = 0 → L′ → L
1
R → p ∈ [0,1], p ≤ → L′ → L )
2
1
p ≥ → R′ → M
2
Hence there is not pure-strategy perfect Bayesian equilibrium.
Now, consider mixed strategy:
Suppose player 1 plays σ = { p1 , p2 ,1 − p1 − p2 } , that is plays L with probability p1 ,

plays M with probability p2 , plays R with probability 1 − p1 − p2 .

p1
Then p = , if p1 + p2 ≠ 0 and p ∈ [0,1] if p1 + p2 = 0
p1 + p2

1
p< → L′ → L
2
1
p > → R′ → M
2
1
p = → σ 2 = (q,1 − q ) for all q ∈ [0,1]
2
 ⎧ L : 3q
⎪
Given σ 2 , payoffs of player 1 is ⎨ M : 3(1 − q )
⎪ R:2
⎩
1
For p = , we need p1 = p2 ≠ 0 or p1 + p2 = 0 . For player 1 to be willing to
2
assign positive probability to both L and M, we need 3q = 3(1 − q) , which implies

⎧ 3
⎪ L: 2
⎪
1 ⎪ 3
q = . Then ⎨ M : , which implies R is the unique optimal choice by player 1,
2 ⎪ 2
⎪ R:2
⎪
⎩

contradicting p1 = p2 ≠ 0 .

1 2
For p1 + p2 = 0 , we need 2 ≥ 3q and 2 ≥ 3(1 − q) , that is ≤q≤ .
3 3
1 2 1
Therefore, { R; σ 2 = (q,1 − q) with ≤ q ≤ ; p = } are all the mixed-strategy
3 3 2
perfect Bayesian equilibria.

u : 0.5 ×1 + 0.5 × 0 = 0.5

R: → aR = d
d : 0.5 × 0 + 0.5 × 2 = 1

4.3 (a) ( R, R ) → p ∈ [0,1], q = 0.5 → ⎧ 1

⎪ u if p ≥
u :2p ⎪ 3
L: → aL = ⎨
d :1 − p ⎪d if p ≤ 1
⎪⎩ 3

1
( R, R) , if p ≥
3
→
1
( R, L), if p ≤
3
We claim that p=0.
The maximum payoff player 1 of type t1 can get from sending “L” is 2, while

if he sends “R”, he can get the equilibrium payoff 3. So “L” for player 1 of type t1 is

off the equilibrium information set, since 2<3. By Requirement 5（cho-kreps criteria）: “In
an off the equilibrium information set m j , the belief should assign zero probability to type ti , if

m j is equilibrium dominated for type ti and condition m j is not equilibrium dominated for
all types.”
1
So p < , (R,R) could not be a pooling perfect Bayesian equilibrium.
3
(b) At first, for player 1 of type t1 , sending “R” is strictly dominated by sending “L”.

So
1
( L, L, L) → p1 = p2 = p3 = , q1 = 0, q2 , q3 ∈ [0,1], q2 + q3 = 1
3
1 1 1
u : ×1 + ×1 + ×1 = 1
L: 3 3 3 → aL = u
d :0
→ ⎧ 1
⎪ u if q2 ≥
u : q2 ⎪ 2
R: → aR = ⎨
d :1 − q2 ⎪d if q ≤ 1
⎪⎩ 2
2
1
( L, L, L) if q2 ≥
→ 2
1
( L, L, R) if q2 ≤
2
1
For player 1 of type t2 , sending “R” is off the equilibrium path, so q2 = 0 ≤ .
2
So (L,L,L) could not be a pooling perfect Bayesian equilibrium.