ECON0013 Microeconomics 1

Problem Set 1

1. Consider the following two person game.

L R P MP
U (3, 2) (0, 0) (1.2, 1) (0, 0)
D (0, 0) (2, 3) (0, 0) (1.4, 1.5)
P (1, 1.2) (0, 0) (0, 0) (0, 0)
MP (0, 0) (1.5, 1.4) (0, 0) (0, 0)

(a) Find all the pure strategy Nash equilibria of this game.
(b) Show that the actions P and M P are strictly dominated for both
players.
(c) Delete the strictly dominated actions and find the mixed strategy
Nash equilibrium of the game that remains.

2. Two buyers (Ann and Bob) are in an auction to acquire an item. They
have five possible bids they can submit b = £0, £1, £2, £3, £4. Ann
values the item at £2 and Bob values the item at £3. If they win the
item they receive utility equal to their value for the object less the price
they paid. If they lose the auction they have utility of zero. The rules of
the auction are: First, the buyers submit their bids in sealed envelopes.
Second, the envelopes are opened and the highest bidder gets allocate
the item. They must pay the price that was written losing (second
highest) bid. Third, if there is a tie in the bids a coin is tossed to
determine who wins.

(a) What are the players’ pure strategies in this game?

(b) Write down the strategic form of this game.
(c) Can you find any weakly or strictly dominated strategies?

3. Two workers (A and B) are on a production line. They can each chose
to exert effort E or to shirk S. It costs each worker 1 > £c > 0 to exert
effort, but shirking costs them nothing. The workers together produce
one unit of output. If the unit passes a quality-control test, then it can
be sold for £2 (shared equally between the workers). If it fails the test
it cannot be sold. The probability of passing the quality-control test is
denoted by p. This depends on how much effort is supplied: p = 0 if
ECON0013 Microeconomics 2

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neither worker exerts effort, p = 2
if one worker exerts effort and p = 1
if two workers exert effort.

(a) Write down the strategic form of this game.

(b) For what values of c can you find dominated actions?
(c) Find a Nash Equilibrium of this game when you cannot eliminate
dominated actions?

4. Firm 1 chooses a location −∞ < x < ∞ and Firm 2 chooses a location

−∞ < y < ∞. Firm 1 prefers to be as close as possible to the location
of its suppliers (at a) but dislikes having a lower location than its
competitor (at y). It has the profits

π1 = 50 − α(a − x)2 + (1 − α)(x − y).

Firm 2 prefers to be as close as possible to the location of its suppliers

(at b) and likes being close to its competitor (at x). It has the profits

π2 = 10 − (b − y)2 − (x − y)2 .

(a) For what values of α is Firm 1’s profit a strictly concave function
of x? When does firm 1 have a best response function (why won’t
weak concavity work)?
(b) Find the Nash equilibrium in this game when α = 1/2. Calculate
the firms’ equilibrium profits.
(c) Determine when firm 1 ends up at a lower location than its com-
petitor.

5. A negotiation is organized as follows. At the first date a union gets to

proposes a wage 0 < w < 1. At the second date, a firm gets to agree
to the wage offer or not. If the firm agrees to the offer, the union gets
the wage proposed and the firm gets θ − w. If the firm refuses the wage
offer the union gets −δ and the firm gets zero. Draw the game tree for
this negotiation and find a Nash equilibrium.