WS 2016/17

Game Theory (MSE)

Assignment 1 Solutions

Question 1
Solution:

w
si = s, j 6= i with sj = s
(a) I = {1, 2, ..., n}, Si = {s, s} i, i ui (si , si ) = 0 sj = s j I (3 points)

wc si = s

(b) 1. sj = s j I
s, si ) = w > ui (s, si ) = w c not an equilibrium.
ui (

2. sj = s j I
s, si ) = 0 not an equilibrium.
ui (s, si ) = w c > ui (
There are, however, n asymmetric pure strategy Nash equilibria with exactly one of the n persons suing , i.e.
with (si = s, sj = s), i I, j I, j 6= i:

ui (si = s, si ) = w c > ui (si = s, si ) = 0

uj (sj = s, sj ) = w > uj (sj = s, sj ) = w c

(3 points)
(c) Let q denote the object of interest, i.e. the individual probability of suing. In any mixed-strategy NE, all
pure strategies in its support must yield equal expected payoffs. So consider the (sure) payoff of suing against
the (uncertain) payoff of not suing:
!
E[ui (s, sj = q )] = E[ui (
s, sj = q )] w c = 0 (1 q )n1 + w (1 (1 q )n1 )
Solving for q :

w c = w (1 (1 q )n1 )
wc
1 = (1 q )n1
w
c 1 c 1
1 q = ( ) n1 q = 1 ( ) n1
w w

Symmetric mixed strategy NE: = (1 = q , ..., n = q ). (3 points)

1 n
(d) Pr(company is not sued) = (1 q )n = (1 q )(1 q )n1 = ( wc ) wc = ( wc )
n1 . n1
c
This probability increases with n (as w < 1).
Hence the probability that the company is sued decreases with the number of damaged persons. (1 point)

Question 2
Solution:
Proceed by backwards induction: in T , any offer will be accepted, so the offering player will offer 0 and retain v for
herself. Anticipating this, in T 1, the responding player can and will reject any offer below v c, so the offering
player in T 1 will in fact offer exactly v c (and retain c), and the responding player will accept. So in T 2,
the responding player will reject any offer below 0 such that the offering player can in fact offer 0 (and retain v),
which will be accepted. So in T 3, the responding player will reject any offer below v c, so the offering player
will offer exactly v c (and retain c), and this will be accepted. Continue likewise until T = 1.
The subgame perfect Nash equilibrium depends on whether T is odd or even.
If T is odd: A will (or rather would) make the final period offer. Her equilibrium strategy is to offer 0 every time
and reject any offer below v c. Bs equilibrium strategy is to always offer v c and accept any offer. The result
is that player A offers 0 in T = 1, B accepts and the game ends (with payoffs (v c, 0)). (5 points)
If T is even: B will (or rather would) make the final period offer. His equilibrium strategy is to offer 0 every time
and reject any offer below v c. As equilibrium strategy is to always offer v c and accept any offer. The result
is that player A offers v c in T = 1, B accepts and the game ends (with payoffs (0, v c)). (5 points)

Question 3
Solution:
(a) Proceed by backwards induction.
Firm 3:
3 = [a b(q1 + q2 + q3 )] q3
!
FOC: q3 = a b(q1 + q2 ) 2bq3 = 0
3

a q1 + q2
q3 (q1 , q2 ) = (1)
2b 2

Firm 2:
2 = [a b(q1 + q2 + q3 )] q2
Substitute (1), i.e. anticipation of the reaction of firm 3:
2 = a2 q2 bq21 q2 2b q22 = q22 (a b(q1 + q2 ))
2 !
FOC: q2 = 0.5(a bq1 2bq2 ) = 0
a q1
q2 (q1 ) = (2)
2b 2
Firm 1:
1 = [a b(q1 + q2 + q3 )] q1
Substitute (1) and (2), i.e. anticipation of the reactions of firm 2 and 3:
1 = ... = a4 q1 4b q12
1 a !
FOC: q1 = 4 2b q1 = 0
a
q1 = (3)
2b

So substituting (3) back into (2) and then this result and (3) back into (1) we get the equilibrium quantities:
a a a 7a 1
q1 = , q = , q3 = Q = p = a
2b 2 4b 8b 8b 8
(5 points)
(b) Best-response functions of firms 2 and 3 (from FOC of profit function, analogous to firm 3 in part a):

a q1 + q3
q2 = (1)
2b 2
a q1 + q2
q3 = (2)
2b 2

Solving (1) and (2) (e.g. by plugging (2) into (1)) yields:
a q1
q2 = q3 = (3)
3b 3

Firm 1 anticipates these responses ( substitute (3) into profit function):

2a 2bq1 aq1 bq 2
1 = [a b(q1 + q2 + q3 )] q1 = aq1 bq12 bq1 = 1
3b 3 3

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 FOC:
1 a 2 !
= bq1 = 0
q1 3 3
a
q1 = (4)
2b
So substituting (4) back into (3) we get the equilibrium quantities:
a a 5a a
q1 = , q = q3 = Q = p =
2b 2 6b 6b 6

(5 points)
(c) This subquestion is a bit more tricky and in fact has many subgame-perfect equilibria (not all of which are
equally convincing). Correct answers to this question count as bonus points.
Notice:
there are no proper subgames, so subgame-perfection is void and any NE are subgame-perfect
for firms 1 & 3, a strategy is just a quantity. In contrast for firm 2, a strategy can be any function of q1
this strategy of firm 2 does not even have to be credible (remember: subgame-perfection is void), it just
has to be a best-response for the actual quantities q1 , q3 )
it must be that (in any interior equilibrium p > 0) 2 and 3 in fact choose the same quantity (otherwise
one of them would not be best-responding), but (only) 2 can react to firm 1s quantity
a q1 +q2
(any interior) q3 must satisfy q3 = 2b 2 . Likewise, the actually chosen q2 must satisfy q2 =
a q1 +q3
2b 2
a a q
For example, any (q1 , q2 , q3 ) with 0 q1 < 2b , q2 = q3 = 3b 31 can be an equilibrium (with correspond-
a q
ing Q and p(Q )), supported e.g. by the following strategy of firm 2: q2 (q1 ) = 3b 31 if q1 = q1 ,
a q
otherwise (or just by q2 (q1 ) = 3b 31 )
Perhaps the most natural (credible) equilibrium would be (derived) as follows (with firm 2 best-responding
not only to actual equilibrium quantities, but to all reasonable beliefs after observing q1 ):
As in (b), the best-response functions of 2 and 3 are:
a q1 + q3
q2 = (1)
2b 2
a q1 + q2
q3 = (2)
2b 2
Suppose firm 2s strategy is to play according to this best-response function (i.e. for any q1 , even for q1 6= q1 ).
Firm 1 anticipates this response (substitutes 2s strategy in its profit function):

a q1 + q3 aq1 bq 2 bq1 q3
1 = [a b(q1 + q2 + q3 )]q1 = aq1 bq12 bq1 q3 bq1 ( )= 1
2b 2 2 2 2
FOC:
1 a bq3 !
= bq1 =0
q1 2 2
a q3
q1 = (3)
2b 2
Solving the three equations (1), (2), (3) yields the equilibrium quantities:
2a a 4a a
q1 = , q = q3 = Q = p =
5b 2 5b 5b 5

Notice: (apart from potential strange equilibrium strategies of firm 2 in subquestion c) all objective functions
are concave and given that all equilibrium quantities based on the FOCs turned out positive, the FOCs were
indeed applicable, i.e. not explicitly considering the possibility of corner solutions (zero production) turned
out to be innocuous.
(5 bonus points)

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