PROBLEMS AND APPLICATIONS with Solutions

Game Theory
Selected by Dr. Brahim Guizani

April 2015
The Solutions are given after the problems
Problem 1
Firm 1 and Firm 2 are movie producers. Each has the option of producing a blockbuster
romance or a blockbuster suspense lm. The payoff matrix displaying the payoffs for each
of the four possible strategy combinations (in thousands) is shown below, with Firm 1s
payoff listed rst. The game is played simultaneously. Determine the Nash equilibrium
outcome.

Problem 2
Harrison and Tyler are two students who met by chance the last day of exams before the end of
the spring semester and the beginning of summer. Fortunately, they liked each other very
much. Unfortunately, they forgot to exchange addresses. Fortunately, each remembers that
they spoke of attending a campus party that night. Unfortunately, there are two such parties.
One party is small. If each attends this party, they will certainly meet. The other party is huge. If
each attends this one, there is a chance they will not meet because of the crowd. Of course,
they will certainly not meet if they attend separate parties. Payoffs to each depending on the
combined choice of parties are shown below, with Tylers payoffs listed rst.

a- Identify the Nash equilibria for this problem.

Problem 3
A game known well to both academics and teenage boys is Chicken.Twoplayerseach drive
their car down the center of a road in opposite directions. Each chooses either STAY or
SWERVE. Staying wins adolescent admiration and a big payoff if the other player chooses
SWERVE. Swerving loses face and has a low payoff when the other player stays. Bad as that is, it
is still better than the payoff when both players choose STAY in which case they each are badly
hurt. These outcomes are described below with Player As payoffs listed rst.

aFind the Nash equilibria in this game.

bThis is a good game to introduce mixed strategies. If Player A adopts the strategy STAY
one-fth of the time, and SWERVE four-fths of the time, show that Player B will then be
indiffer ent between either strategy, STAY or SWERVE.
cIf both players use this probability mix, what is the chance that they will both be badly
hurt?

Problem 4
You are a manager of a small widget producing rm. There are only two rms,
including yours, that produce widgets. Moreover your company and your competitors are
identical. You produce the same good and face the same costs of production described by the
following total cost function: Total Cost= 1500+ 8q where q is the output of an individual rm.
The market- clearing price, at which you can sell your widgets to the public, depends on how
many widgets both you and your rival choose to produce. A market research company has
found that market demand for widgets can be described as: P = 200 2Q where Q= q1+ q2,
where q1 is your output and q2 is your rivals. The Board of Directors has directed you to choose
an output level that will maximize the rms prot. How many widgets should your rm
produce in order to achieve the prot-maximizing goal? Moreover you must present your
strategy to the Board of Directors and explain to them why producing this amount of widgets is
the prot-maximizing strategy.

Solutions
Problem 1
The unique Nash equilibrium is: (Suspense, Suspense). In each of the other three possible
outcomes (Romance, Romance), (Romance, Suspense), and (Suspense, Romance), at least one
rm has an incentive to switch its strategy.
Problem 2
a- This is a classic matching problem. The easiest way to find the Nash equilibrium is to first
eliminate from each row the dominated strategies for Harrison. Harrison has the second payoff
in each pair. Looking at the first row, if Tyler chooses small (S), Harrison should also choose
small. Thus the point (S,L) in the upper right-hand corner can be eliminated. Looking at the
second row, if Tyler chooses large (L), then Harrison should also choose large. Thus the point
(L,S) in the lower left-hand corner can be eliminated. Now we move to the dominated
strategies for Tyler. If Harrison chooses the first column (S), then Tyler should also choose
small. This is already removed and so we gain no information. Unfortunately checking the
second column also yields no new information and we are left with the two Nash Equilibria (S,S)
and (L,L).

Problem 3

a-

The equilibria are the two off-diagonal elements.

b- To solve this problem we need to use expected values. If player B chooses to Stay his
expected payoff is given by the payoffs to staying weighted by the probabilities that player
A will Stay or Swerve.

If player B chooses to Swerve his expected payoff is given by the payoffs to staying weighted by
the probabilities that player A will Stay or Swerve.

c- The easiest way to see this is to add the probabilities to the border of game matrix and then
compute the joint probabilities in each cell.

The probability of (Stay, Stay) is 1/25.

Problem 4
To determine my best response function, I equate my marginal revenue with my marginal cost
200 4Q1 2Q2 8 Q1

1
200 2Q2 8
4

Since my rival and I are identical,

Q1* Q2* Q*

1
192 2Q* Q* Q* 32 P 72
4

My profit is
( 72 8 )32 1500 548

Note: Because of the fixed cost, there are two other asymmetric equilibria. At each, one firm
produces its monopoly output and the other produces none. We assume that in this case, a
symmetric equilibrium is more reasonable than an asymmetric equilibrium.