Winter 2021

Microeconomics II
Game Theory and Strategic Behavior

Dr. Wided Hemissi

Exercise 1:
1. Does either player in the following game have a dominant strategy? If so, identify it.
2. Does either player in the following game have a dominated strategy? If so, identify it.
3. What is the NE In this game?

Exercise 2:
ABC and XYZ are the only two firms selling gadgets in Europe. The following table shows the
profit (in millions of euros) that each firm earns at different prices (in euros per unit). ABC’s profit is
the left number in each cell; XYZ’s profit is the right number.
Is there a unique Nash equilibrium in this game? If so, what is it? If not, why not? Explain clearly how
you arrive at your answer.

Exercise 3: (The Auction Game)

Professor Nash announces that he will auction off a $20 bill in a competition between Jack and Jill,
two students chosen randomly at the beginning of class. Each student is to privately submit a bid on a
piece of paper; whoever places the highest bid wins the $20 bill. (In the event of an equality, each student
gets $10). The catch, however, is that each student must pay whatever he or she bid, regardless of who
wins the auction. Suppose that each student has only two $1 bills in his or her wallet that day, so the
available strategies to each student are to bid $0, $1, or $2.
1. Write down a 3 x 3 payoff matrix describing this game.
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2. Does either student have any dominant strategy? If so, what is it?
3. Does either student have any dominated strategies? If so, what is it?
4. What is the Nash equilibrium in this game?
5. Suppose that Jack and Jill each could borrow money from the other students in the class, so that
each of them had a total of $11 to bid. Would ($11, $11) be a Nash equilibrium? Why?
Exercise 4: (Mixed Strategies)
Consider the following baseball game where the pitcher has to decide whether to throw a fast
ball or a curve ball. The batter has to decide whether to swing or not swing.

1. Is there a NE in pure strategies in this game?

2. Is there a mixed strategy NE in this game? If so, what is it?

Exercise 5: (Mixed Strategies)

Consider the following game:

1. Is there a NE in pure strategies in this game?

2. Find the mixed strategy NE.
3. Suppose the payoff of Player 2 is reduced from 8 to 6, but all other payoffs remain the same.
Find all the pure and mixed strategy NE.

Exercise 6: (Sequential-move Games)

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In the mid-1990s, Value Jet wanted to enter the market serving routes that would compete head to
head with Delta Airlines in Atlanta.
Value Jet knew that Delta might respond in one of two ways: Delta could start a price war, or it
could be ‘accomodating’, keeping the price at a high level. Value jet had to decide whether it would
enter on a small scale or on a large scale. The annual profits (in millions of dollars) associated with
each strategy are summarized in the following table:

1. If Value Jet and Delta choose their strategies simultaneously,

a. What strategies would the two firms choose at the NE?
b. What would be the payoff for Value Jet? Explain.
2. Suppose that Value Jet decided to move first, entering on a small scale. It communicated
this information by issuing a public statement announcing that it had limited
aspirations in this marketplace and had no plans to grow beyond its initial small size.
a. Analyze the sequential game in which Value Jet chooses ‘small’ or ‘large’ in the first
stage and then Delta accommodates or starts a price war in the second stage.
b. Did Value Jet enhance its profit by moving first and entering on a small scale? If so,
how much more did it earn with this strategy? If not, explain why not?

Exercise 7: (Sequential-move Games)

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Two firms are competing in an oligopolistic industry. Firm 1, the larger of the two firms, is
contemplating its capacity strategy, which could be either ‘aggressive’ or ‘passive’. The aggressive
strategy involves a large increase in capacity aimed at increasing the firm’s market share, while the
passive strategy involves no change in the firm’s capacity. Firm 2, the smaller competitor, is also
pondering its capacity expansion strategy; it will also choose between an aggressive strategy
and a passive strategy. The following table shows the profits associated with each pair of choices:
Firm 2
Aggressive Passive
Firm 1 Aggressive 25, 9 33, 10
Passive 30, 13 36, 12

1. If both firms decide their strategies simultaneously, what is the NE?

2. If Firm 1 could move first and credibly commit to its capacity expansion strategy, what is its
optimal strategy? What will Firm 2 do?
Exercise 8: (Merger Game with 3 Players)
What is the NE in this game?

Exercise 9: (Cooperation in a Sequential Move Game)

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Alice and Bob play the following game: Alice goes first and chooses A, B or C. If she chose A,
the game ends and both get 0. If she chose B, Bob can either choose D resulting in utilities of 2 and 3,
or he can choose E, resulting in utilities -2 and 2. If Alice chose C, Bob can either choose F resulting
of utilities of 3 and 5, or G, resulting in utilities of -6 and 6.
1. Draw the tree for the game.
2. Find the NE in the sequential move game.
3. Suppose that players can cooperate. What is the cooperative solution? Bob says he will cooperate.
Is he credible?
4. Suppose that if Alice chooses A, her payoff is now 4 instead of 0. Find the new NE.
Exercise 10: (The Invasion Game)
Consider the following game: An alien civilization invades earth and humans need to decide
whether to abandon their planet or to stay put. If they stay and the aliens fight, both get a payoff of 0,
whereas if the aliens run away, humans get 2 and aliens get 1. If humans run away, they get 1 and the
aliens get 2.
Immediately after landing on earth, the alien commander needs to decide whether to destroy his
spaceships (and thus eliminating the option to run away if humans decide to stay put).

Exercise 11: (Final Fall 2019)

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This problem discusses some issues related to the provision of public goods. Two individuals are
facing the decision to contribute or not to the provision of a public good (a shared kitchen for example).
Public goods are non-excludable and thus benefit everyone once provided. However, a higher level of
public good results when everyone contributes. Individual contribution costs 𝑐 ∈]1,2[. Payoffs can be
summarized in the following matrix: Player 2

contribute don’t contribute

contribute 2-c, 2-c 1-c, 1
Player 1 1, 1-c 0, 0
don’t contribute
The problem of under-provision:
1. Find the NE in the simultaneous game described above.
2. Explain why this is a case of prisoners’ dilemma. Define the cooperative outcome.
3. One way to remedy to this dilemma is to lower the individual contribution cost c through
government financial help. What values of c make (contribute, contribute) a NE.
4. A second way to promote collaboration is to explain to players that this is a repeated game.
Explain in detail two factors that increase the likelihood of collaboration in a repeated prisoners’
dilemma.

The problem of free riding:

5. The game is now asymmetric. Player 1 enjoys the provision of the public good more than Player
2 (Player 1 cooks more often for example). Namely, the payoffs matrix becomes as follows:
Player 2

contribute don’t contribute

Player 1 contribute 3-c, 2-c 2-c, 1
don’t contribute 2, 1-c 0, 0

We still have 𝑐 ∈]1,2[. Find the new NE.