Some Problems:

1. a. What is backward induction or programming? Explain how you solve finite games of perfect
information using backward induction or programming.
b .Two players, 1 and 2, bargain to determine the split of v dollars. The rules are as follows: the game
begins in period 1 when player 1 makes an offer of a split between 0 and v to player 2 which player 2
may accept or reject. If she accepts, the game ends. If rejects, nothing happens until period 2 when
player 2 makes a counter offer. Each player has a discount factor of δ ϵ (0, 1). However, after some finite
number of periods T, if an agreement has not yet been reached, the bargaining is terminated and the
players each receive nothing.
(i) Find the SPNE in this game. (ii) Suppose the discount factors δ 1 and δ2 of the two players differ. Now
what is the new SPNE? (iii) Instead of discounting future payments assume that it costs c to make an
offer. Only the player making an offer incurs this cost, and players who have made offers incur this cost
even if no agreement is ultimately reached. What is the new SPNE?

2. a. Explain the rationale for PPP theoretically.

b. When do you prefer 'conventional' provision to PPP?
c. What are the purposes of the Government of Bangladesh behind introducing PPP?

3. a. Derive the Samuelson condition for optimal level of public good and explain it.
b. Let U1 = x + y1, U2 = 2x + y2, U3 = 5x + y3, and the cost of public good x, g(x) = 1/2x2.
Each agent is endowed with 24 units of the private good.
(i) Find the socially optimal level of public good x using Samuelson condition.
(ii) What will be the U1 for optimal values of public good given that he/she bears a fraction
of the total cost of the public good in proportion with his/her benefit?
(iii) What will happen when there is no social planner to enforce the socially optimal
level of public good?
(iv) Show that they (i.e., agents) will not reveal their true benefits from public good to avoid
cost sharing.

4. a. Define (i) A Game (ii) Nash Equilibrium and (iii) Bayesian Nash Equilibrium.
b. The Alphabeta research and development consortium has two (noncompeting) members, firms 1
and 2. The rules of the consortium are that any independent invention by one of the firms is shared
fully with the other. Suppose that there is a new invention, the “Zigger,” that either of the two firms
could potentially develop. To develop this new product costs a firm c ϵ (0,1). The benefit of the Zigger
to each firm i is known only to that firm. Formally, each firm i has a type θ i that is independently
drawn from a uniform distribution on [0,1], and its benefit from the Zigger for type θ i is (θi)2. The
timing is as follows: The two firms each privately observe their own type. Then they each
simultaneously choose either to develop the Zigger or not.
(i) Solve for the Bayesian Nash Equilibrium of this game.
(ii) Show that a free-rider problem arises here and explain why.
(iii) Find the probabilities that neither firm develops, exactly one firm develops, both the firms
develop the Zigger.

5. a. Derive "Pigouvian tax," in the context of environmental externalities and explain it.
b. According to the Coase Theorem, the optimal levels of pollution and output can result from
bargaining between polluters and their victims if property rights are clearly defined. Explain this
statement.
c. What are the limitations of Coase Theorem in solving problems associated with externalities?

6. Consider two firms, a chemical plant (called it ‘C’) and a boat rental company (called it ‘R’), that share
a small lake. C dumps its waste by-products, which smell bad but are otherwise harmless, into the lake. C
can reduce pollution only by restricting its output; it has no other outlet for this waste. The resulting
pollution damages R’s business. People dislike the smell of the chemicals and there are other lakes
nearby where they can rent boats. Therefore, people rent from R only if it charges a low enough price to
compensate them fully for the smell. Following is the profit matrix when no property right is defined.
R: Boats rented per day
0 1 2
0 0 , 0 0 , 14 0 , 15
1 10 , 0 10 , 10 10 , 5
2 15 , 0 15 , 2 15 , -3

C: Tons per day

(i) Find the no-property-rights equilibrium. (ii) Solve the problem using Coase Theorem when the
property right is given to C. (iii) What differences do you see when the property right is given to R?

7. Suppose there are two firms, A and B, in an industry. Each produces a product, which is a direct
substitute of the other. There are two strategies available to each firm: advertise and do not advertise.
Assume that advertising costs Tk 10 lakh. When neither firm advertises, each firm earns a profit of Tk 50
lakh. If one firm advertises and the other does not, some customers switch from the latter to the former.
The former advertising firm’s (net) profit is Tk 60 lakh, while the latter earns a profit of Tk 30 lakh. If both
firms advertise, then their profits are Tk 40 lakh each.
(i) Write the payoff matrix of this game.
(ii) What is the Nash equilibrium of this game?
(iii) Is this game analogous to the Prisoner’s dilemma game? How?

8. Table 1 shows the payoffs (profits) for duopolists who can each choose among the three strategies
Zero, Small, or large levels of output.
Table 1: Profits in duopoly
Output of Firm B
Zero Small Large
Output Zero 0, 0 0, 1500 0, 2000
of Small 1500, 0 1300, 1300 800, 1400
Firm A Large 2000, 0 1400, 800 500, 500
a) Firm A moves first, then firm B. (i) Find the subgame-perfect equilibrium (ii) Is there a first-mover or
last-mover advantage? (iii) Is the solution efficient for the two firms together? (iv) Can an efficient
outcome for the two firms could hurt consumers?

b) Answer the same questions, but now assume that after firm B responds to A’s initial choice, firm A can
then revise its own decision. (Thus firm A has both the first move and the last move.)

c) Using Table 1, now assume a simultaneous-move game. (i) Are there one or more dominant strategy
equilibria? (ii) Are there one or more Nash equilibria?

9. A and B are neighbors. Each is bothered by the amount of garbage discharged in the vicinity. If A
supplies eA units of effort to cleaning up then A and B will each derive 2eA units of benefit. Similarly, if B
supplies eB units of effort to cleaning up then A will receive 2eB units of benefit from that activity, and so
will B. Assume that each unit of effort expended by an agent reduces the agent’s utility by 3 units.
(a) Restricting ei between 0 and 1 inclusive, solve for the social optimal.
(b) For the same restriction on e i solve for the Nash equilibrium prediction of the game. Find the
dominant strategies for both the players.

10. Explain briefly why international trade occurs among countries using various trade theories. How do
these theories relate to microeconomics?