Mathematics for Economists-1

Sections 7 (Problem set 6), October 18, 2023

Alexander Tonis, Kirill Savin

0. (Ch. 10.5, Exercise 7) Let x ∈ S = [0, 1] and θ ∈ Θ = R+ . In each of the following cases, determine
if the given function is supermodular in (x, θ). In each case, determine also if the optimal action
correspondence in the problem max{f (x, θ) | x ∈ S} is nondecreasing in θ.
(a) f (x, θ) = xθ − x2 θ2 .
Solution
∂ 2 f (x, θ)
= 1 − 4xθ ⇒ f is strictly supermodular in (x, θ) (for all x ∈ [0, 1]) if θ ∈ [0, 1/4] and is
∂x∂θ
not supermodular if θ can be higher than 1/4.
Let D∗ (θ) := arg max{f (x, θ) | x ∈ S}. If θ > 0, then f is strictly concave in x and the FOC for
∂f (x, θ)
an interior solution is = θ − 2xθ2 = 0 ⇒ D∗ (θ) = min(1/(2θ), 1) and D∗ (0) = [0, 1].
∂x

The optimal actions are weakly increasing in θ for θ ∈ [0, 1/2]. Thus, supermodularity is sufficient
but not necessary for monotonicity.
(b) f (x, θ) = xθ − x2 .
Solution
∂f (x, θ)
= θ − 2x is increasing in θ and decreasing in x ⇒ f is strictly supermodular in (x, θ)
∂x
and strictly concave in x ⇒ D∗ (θ) = min(θ/2, 1). The optimal action is weakly increasing in θ.

(c) f (x, θ) = x/(1 + θ).

Solution
∂f (x, θ)
= 1/(1+θ) > 0 is decreasing in θ ⇒ f is strictly supermodular1 in (x, −θ) and D∗ (θ) ≡ 1.
∂x
1
To deal with decreasing parametric monotonicity, one can redefine parameters or variables, e.g. use θ0 = −θ instead of θ.
 (d) f (x, θ) = x(1 + θ).
Solution
∂f (x, θ)
= 1 + θ > 0 is increasing in θ ⇒ f is strictly supermodular in (x, θ) and D∗ (θ) ≡ 1.
∂x
(e) This task is identical to (b), so probably there is a typo. I suppose that the following function is
meant: f (x, θ) = x(x − θ).
Solution
∂f (x, θ)
= 2x − θ is decreasing in θ and increasing in x ⇒ f is strictly supermodular in (x, −θ)
∂x

 1 if θ < 1,
and strictly convex in x ⇒ the solution is at x = 0 or x = 1 ⇒ D∗ (θ) = {0, 1} if θ = 1,
0 if θ > 1.


The optimal actions are weakly decreasing in θ.

1. (Signaling) Let S := {1, 2} be the set of actions available to a set of economic agents. Each agent
has a privately known type θ which belongs to the set Θ := {1, 2}. The action x selected by the agent
is observed in the labor market and rewarded at the wage rate w(x). In turn, c(x, θ) is the cost of
action x for an agent of type θ, leading to a net payoff π(x, θ) := w(x) − c(x, θ). Say that the wage
scheme w(·) separates the high type agent from the low type if each type θ has a unique optimal action
x∗ (θ) such that x∗ (2) > x∗ (1).

(i) What conditions on the cost function c(·, ·) would be sufficient for the existence of a wage scheme
w(·) that separates the high type agent from the low type? Explain your answer.
Solution
A wage scheme w(·) given by w(1) and w(2) separates the high type agent from the low type if
x∗ (1) = 1 and x∗ (2) = 2 ⇔ π(1, 1) > π(2, 1) and π(2, 2) > π(1, 2) ⇔ w(1)−c(1, 1) > w(2)−c(2, 1)
and w(2) − c(2, 2) > w(1) − c(1, 2) ⇔ c(2, 2) − c(1, 2) < w(2) − w(1) < c(2, 1) − c(1, 1). There
exists a wage scheme satisfying these inequalities if −c(·, ·) is strictly supermodular.
(ii) Assuming c(·, ·) is a C 2 function on R2 , suggest an alternative answer to question (i) in terms of
the derivatives of c.
Solution
Using the second-order characterization of supermodularity, we obtain the following sufficient
∂ 2 c(x, θ)
condition: there exists a separating wage scheme if < 0 for (x, θ) ∈ (1, 2)2 .
∂x∂θ

2. (Bertrand price competition with linear demand) Consider 2 firms competing in prices. If the
vector of prices chosen by the firms is p = (p1 , p2 ) ∈ R2+ , the total demand for firm i’s product is given
by

qi (p) = 2 − pi + pj
 where pi is the firm’s own price and pj is the other firm’s price.(For simplicity, we are allowing for the
case qi (p) < 0.) The profit of firm i is given by

πi (p) = (pi − ci )qi (p).

where ci ≥ 0 is a parameter that represents the cost of producing one unit of output for firm i.
A Nash equilibrium is a price vector p∗ = (p∗1 , p∗2 ) such that p∗i solves the following problem for each
firm i:

max πi (pi , p∗j )

pi ∈R+

Without using the first order conditions, show that there cannot exist two Nash equilibria p∗ and p̂∗
such that p∗1 < p̂∗1 and p∗2 > p̂∗2 .
Solution
2
Firstly, let us show that πi (p) is strictly supermodular: ∂∂pπi ∂p
i (p)
j
= 1 > 0 ∀pi , pj , i 6= j. By symmetry,
the same is true for πj (p). Strict supermodularity implies strict increasing differences (in this case
these two properties are actually equivalent).
Now, suppose by contradiction that ∃p∗ , p̂∗ such that p∗1 < p̂∗1 and p∗2 > p̂∗2 .
As p∗ and p̂∗ are the solutions ⇒ π1 (p∗1 , p∗2 ) ≥ π1 (p̂∗1 , p∗2 ) and π1 (p̂∗1 , p̂∗2 ) ≥ π1 (p∗1 , pˆ∗2 ).
Strictly increasing differences property of π1 (p) and p∗ , p̂∗ being the solutions imply:

0 ≥ π1 (p̂∗1 , p∗2 ) − π1 (p∗1 , p∗2 ) > π1 (p̂∗1 , p̂∗2 ) − π1 (p∗1 , pˆ∗2 ) ≥ 0.

A contradiction. Hence, @p∗ , p̂∗ satisfying these inequalities.

3. Consider a function π : R3 → R defined as

π(w, x, θ) = w + u(x, θ) ∀(w, x, θ) ∈ R3 .

2
Here, u : R2 → R is a C 2 function such that ∂ ∂x∂θ u(x,θ)
> 0 for every (x, θ) ∈ R2 . Pick some numbers
θ1 , θ2 , N1 , N2 ∈ R such that θ1 6= θ2 . Show that there can be at most one pair (w, x) ∈ R2 that satisfies
both of the following equations:

π(w, x, θ1 ) = N1 , π(w, x, θ2 ) = N2 . (1)

That is, if this system of equations has a solution (w, x), then there exists no other solution (w0 , x0 ).
(Intuitively, this means that the indifference curves associated with π(·, ·, θ1 ) and π(·, ·, θ1 ) can intersect
at most one point. This is the source of the term single crossing property.)
Solution
∂ 2 u(x,θ)
Note that ∂x∂θ > 0 implies strict supermodularity of u.
Suppose that there exists another solution (w0 , x0 ). Then

π(w0 , x0 , θ1 ) = N1 , π(w0 , x0 , θ2 ) = N2 . (2)

Subtract (2) from (1):

w + u(x, θ1 ) − w0 − u(x0 , θ1 ) = w + u(x, θ2 ) − w0 − u(x0 , θ2 ) = 0 ⇒
u(x, θ1 ) − u(x0 , θ1 ) = u(x, θ2 ) − u(x0 , θ2 )
which is not consistent with supermodularity of u if x 6= x0 . Hence x = x0 ⇒ w = N1 − u(x, θ1 ) =
N1 − u(x0 , θ1 ) = w0 . Thus, (w, x) = (w0 , x0 ).