Managerial Economics HRM (Term 1 2014)

Problem Set 4
Problem Set on Game Theory

1.
Consider the following simple auction scenario. Two individuals, player 1 and
player 2, are competing in an auction to obtain a valuable object. Each player bids in a
sealed envelope, without knowing the bid of the other player. The bids must be in
multiples of $100 and the maximum that they can bid is $500. The object is worth $400
to player 1 and $300 to player 2. The highest bidder wins the object. In case of a tie,
Player 1 gets the object. The winner pays whatever she bids. So, if the value of the object
for player i is x and player i wins the object by bidding a price p, her payoff is x - p: If
she does not win the object her payoff is zero.
Write down the game in normal (payoff matrix) form.
Is there a strictly dominant strategy for any player in this game?
Is there a weakly dominant strategy for any player in this game?
What is / are the Nash equilibrium / equilibria?
2.
Consider the following model of price competition. Two firms set prices in a
market whose demand curve is given by the equation Q = 6 p, where p is the lower of
the two prices. If firm 1 is the lower priced firm, then it is firm 1 that meets all of the
demand; conversely, the same applies to firm 2 if it is the lower priced firm. In case they
post the same price they each get half the market. Prices can be only be quoted in dollar
units, such as 0, 1, 2, 3, 4, 5, or 6 dollars. Suppose, furthermore, that costs of production
are zero for both firms, and each firm aims to maximize its own profits.
Write down the game in normal (payoff matrix) form.
What is / are the Nash equilibrium / equilibria?
3.
Two people are engaged in a joint project. If each person puts in the effort xi,
a non-negative number equal to at most 1, which costs her c (xi) = x2i the outcome of the
project is worth 3 x1 x2. The worth of the project is split equally between the two people
regardless of their effort levels.
Formulate this situation as a strategic game, and find its Nash equilibrium.
4.
In an envelope game the two players are given an envelope each, containing $1.
Beginning with player 1, the players sequentially call continue or stop. When a
player says continue $1 is removed from his envelope and $2 is added to the envelope
of the other player. If a player says stop, the game ends. If none of the players stopped
the game, the game ends after 4 rounds (2 calls for each player). When the game ends the
players get the amount of money left in their respective envelopes.

Represent the game as a game tree.

When will the game end? What will be the payoffs?
5.
The board of a company has three members X, Y and Z. The board meets to
decide on the marketing plan of the company. There are three alternatives A, B and C.
The payoffs to the board members from different marketing plans are as follows:
UX(A) = UY(B) = UZ(C) = 2
UX(B) = UY(C) = UZ(A) = 1
UX(C) = UY(A) = UZ(B) = 0
Clearly, the board cannot reach unanimity. So, they decide to vote. The alternative with
the most votes wins. If no alternative receives majority, then X exercises her veto in favor
of alternative A and A is selected. Find all possible pure strategy equilibria for this game.
6.
There are only two manufacturers of heavy trucks that specialize in moving wide
loads on the highways: Rayland' Rotors Inc (RR) and Calco Corp (CC). Because they
expect a booming economy, both are contemplating expansions of their manufacturing
capacities. Each could choose a "modest" or a "large" expansion in capacity. The annual
profits (in $ millions) that each company could expect from its choice are shown below.
Heavy
RR CC Modest
Modest
30, 50
10, 30
Heavy
40, 20
20, 40
Also, because of a recent employee defection from RR to CC, CC knows RR's likely profits
and RR is aware of this. But RR does not know CC's likely profits. So, even though CC
knows all the figures in the above pay-off matrix, to RR it looks like the following:
Heavy
RR CC Modest
Modest
30, ?
10, ?
Heavy
40, ?
20, ?
RR's board of directors is scheduled to meet next week to decide and announce its decision
on RRs expansion plan. CCs board of directors is scheduled to meet one month later to
make its capacity expansion decision.
During a strategy meeting at CC's headquarters last week one of its mid-ranked managers
suggested that CC should immediately "leak" its likely profit outcomes to the confederation
of industries, of which both RR and CC are members. Assume that RR will trust CCs
figures because they know that it will be costly for CC to bluff while they use the
confederation as a media. Should the managers suggestion be followed? Why or why not?
Just now the news came in that RR postponed its board meeting to the same day and
same hour as CCs board is scheduled to meet to decide and announce its capacity
expansion decision. Because of the tight schedule of its board members, it is not possible

to reschedule CCs board meeting. Now should the employee's suggestion be followed?
Why or why not.
7.

Consider the following game:

2

1, 1

-1, 5

5, -1

0, 0

In every period when this game is played the players expect the game to be repeated in
the next period with probability p. However, they dont discount future payoffs.
Construct a grim trigger strategy for the players such that (U, L) is the outcome in each
period.
Find the range of values of p for which the grim trigger strategy helps in maintaining the
outcome (U, L).
Now suppose each player gets access to an action X. If a player uses the action X, it
inflicts a payoff of 100 on the opponent. However, the action X could be used only
once. If the action X is used against a player, that player cannot retaliate by using the
same action. Using this action X formulate a grim trigger strategy to maintain the
outcome (U, L). Now recalculate the range of values of p for which the modified grim
trigger strategy (where X is used) helps in maintaining the outcome (U, L).