MGT – Team assignment week 1 1

Mathematics and Game Theory

Team assignment week 1
Representation of games

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Exercise 1.1
Consider the following situation. There are two players, called the proposer and the responder. Their
task is to allocate $10 between them by negotiation. The negotiation follows a certain protocol. First,
the proposer announces one of three possible allocations of the money:

• Keep: the proposer gets $10, the responder gets $0,

• Share: the proposer gets $5, the responder gets $5,
• Give: the proposer gets $0, the responder gets $10.

The responder observes the announced allocation and can then herself decide to:

• Accept: payoffs are realized as specified in the announcement,

• Reject: both players receive $0. (the negotiation has failed, and the money vanishes)

a) Represent this game in the extensive form.

b) Draw the normal-form matrix of this game.

Answer space:
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Exercise 1.2
Consider this simple game played by two players. Each player has a penny and must secretly turn the
penny to heads or tails. The players then reveal their choices simultaneously. If the pennies match,
that is both pennies show heads or both show tails, then player 1 wins and keeps both pennies. If the
pennies do not match, i.e., one is heads and one is tails, then player 2 wins and keeps both pennies.
Assume that payoffs are in cents and correspond to the cents won or lost in the game.

a) Draw the normal-form matrix of the game.

b) Represent this game by means of two alternative extensive forms.

Let’s now change the structure of the game. Player 1 now moves first, then, after having observed
player 1’s penny, player 2 moves second.

c) Represent this new game in an extensive form and compare it to b).

Answer space:
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Exercise 1.3
Consider a Stackelberg duopoly market. Firm 1 and firm 2 both produce quantities 𝑞1 and 𝑞2 of the
same good. Assume that the good is divisible so that 𝑞1 , 𝑞2 ∈ R+ . They produce the good at the same
unit costs of 𝑐1 = 𝑐2 = 𝑐. The linear demand function is given by 𝑝(𝑄) = 𝑎 − 𝑏 ∗ 𝑄, with 𝑎 > 𝑐 > 0,
𝑏 > 0, and 𝑄 = 𝑞1 + 𝑞2 .

Both firms seek to maximize profits (revenues - costs) taking into account the quantity of the other
firm, but firm 1 is the leader. That is, first firm 1 sets her optimal 𝑞1 , then firm 2, after observing 𝑞1 ,
sets her quantity 𝑞2 .

a) Write down the normal form of this game.

b) Represent this game in an extensive form.

Answer space:
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