ECON401: Problem Set 6.

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© 2023 Noriko Ozawa

ECON401: Applied Microeconomic Analysis

Problem Set 6.2: Repeated Game

1. Two firms (A and B) are considering bringing out competing brands of healthy chips. Payoffs to the
companies are shown in the table:

Firm B
Produce Don’t produce
Produce 3, 3 5, 4
Firm A
Don’t produce 4, 5 2, 2

a) Find a pure strategy Nash equilibrium (equilibria) for this game.

b) Consider the following dynamic version of the game in which Firm A first chooses its strategies
and then Firm B, after observing Firm 1’s choice, chooses its strategy. Draw the tree diagram of
this sequential-move game and find a subgame perfect Nash equilibrium.

c) Which of Nash equilibria you find a) would be eliminated by the method of backward
induction? State clearly the non-credible threat involved in this Nash equilibrium and explain
why it is not credible.

2. An industry consists of two firms. They produce a differentiated product and compete over prices.
Each firm chooses either to charge $4 or $3 for one unit of its product. If both firms charge $4, each
will earn the profit of 48. If both firms charge $3, each will earn the profit of 45. If one firm charges
$3 and the other charges $4, then the former will earn the profit of 51 whereas the latter will earn the
profit of 40. The profits of the firms are summarized in the matrix below.

Firm 2
Set p 2 = 4 Set p 2 = 3
Set p1 = 4 48, 48 40, 51
Firm 1
Set p1 = 3 51, 40 45, 45

a) Suppose that Firm 1 and 2 interact with each other 3 times. What is the subgame perfect Nash
equilibrium?

b) Suppose now that Firm 1 and 2 interact with each other infinite period of times. Suppose
further that both firms agree to employ the following strategies:
o if both firms charge $4 this period, they will continue to charge $4 next period.
o if either firm has ever charged $3, they will charge $3forever.
Derive the condition under which the strategies described above constitute a SPNE.

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 ECON401: Problem Set 6.2
© 2023 Noriko Ozawa

3. Consider an industry consisting of two firms, firm 1 and firm 2. They produce a homogenous
product and compete over quantities. If both firms produce 30 units per period, each will earn the
profit of 18. If both firms produce 40 units per period, each will earn the profit of 16. If firm i
produces 40 units and firm j produces 30 units, then firm i will earn the profit of 20 and firm j will
earn the profit of 15, i (i = 1, 2).
Firm 2
Set q 2 = 40 Set q 2 = 30
Set q1 = 40 16, 16 22, 15
Firm 1
Set q1 = 30 15, 22 18, 18

Suppose the two firms enter a collusive agreement in which each produces 30 units; if, however,
either firm has ever derivate from this agreement by producing 40 units, then they will produce 40
units thereafter.

a) Derive the conditions under which the collusive agreement is sustainable at a subgame perfect
Nash equilibrium.

b) Suppose that it takes two periods to discover whether the other firm cheats on the collusive
agreement. Find the condition under which the collusive agreement is sustainable at a subgame
perfect Nash equilibrium.

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