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Universidad Carlos III de Madrid
GAME THEORY
Problem set on
dynamic games
- The next figure shows the tree of a perfect information game G between two players.
a) Identify the information sets of each player (use a Greek letter).
b) Which are the pure strategies of each player? Which are the actions in each information
set?
c) What is the outcome after playing the strategy combination ( rll , LM ), where rll is the
strategy of the first player and LM the strategy of the second player?
d) Identify all possible combinations of strategies (one for each player) that result in the path
rRl.
- Consider the following extensive form game.
a) Indicate which are the feasible strategies for each player and find the subgame perfect
Nash Equilibria.
b) Write the equivalent normal form of this game and find its Nash Equilibria.
- Imagine that the market for vacuum cleaners was dominated by a firm called Rapilimpia and
that a new firm, Neolimpia, was considering entry into this market. If Neolimpia enters,
Rapilimpia has two choices: either to accommodate the entry of Neolimpia, accepting a decrease
in its market share, or to fight entry starting a war price. Suppose that if Rapilimpia decides to
accommodate the entry of Neolimpia, the latter would have a profit of 10 millions euros; but if
Rapilimpia chooses a war price, Neolimpia would loose 20 millions euros. Obviously, if
Neolimpia does not enter to the market, its profits are zero. Additionally, suppose that as a
monopoly, Rapilimpia can obtain profits of 30 millions of euros, that to share the market with its
competitor will reduce its profits to 10 million and that a war price will cost to the firm 10
millions.
a) Draw the extensive form game.
b) Now use the extensive form game to obtain the strategic form game and obtain all the
Nash equilibria in pure strategy. Which of these Nash equilibria are subgame perfect?
- Merche and Antonio have to decide where to go on vacation. They have three options:
Alicante (A), Barcelona (B) or Córdoba (C), but they do not reach an agreement where to go. In
order to take a decision they use the following mechanism. First, Merche vetoes one of the three
places. Then, Antonio, after observing Merche’s veto, vetoes another place. They go to the place
that has not been voted. Merche prefers A to B and B to C; Antonio prefers C to B and B to A.
Assuming that each player assigns an utility of 3 to the favored place, an utility of 2 to the
second best alternative and an utility of 1 to remaining city, and that both players want to go
together on vacation, answer to the following questions:
a) Represent the game in extensive and normal form.
b) Find the Nash equilibrium/a in pure strategies.
c) Which of the Nash equilibria previously found are subgame perfect Nash equilibria?
Explain your answer. Where do Merche and Antonio go on vacation?
- Two Spanish firms share the dairy market of Getafe. One of them, called OBESA, only sells
fat products. The other firm, called LISA, only sells non- fat products. It is well known that in
Getafe people are not too worried about being thin and that if LISA does not launch an
aggressive advertisement campaign about the risks of being overweight, LISA and OBESA
profits would be 1 and 6 millions euros respectively. On the contrary, if LISA launch its
campaign, OBESA has the choice of fighting back with a publication of a dossier warning
consumers about the lack of vitamins in non-fat products of her rival. In this case, LISA can even
do something else, by launching a public message about the lack of healthy and cleaning
measures in the production facilities of OBESA. The marketing department of both firms
forecast that if LISA launch its campaign against overweight and OBESA does not react with the
dossier, profits would be of 4 millions of euros for LISA and of 3 for OBESA. On the contrary, if
OBESA reacts, after LISA launches its campaign, by publishing the dossier and LISA does not
react to this action, profits would be of 2 millions euros for LISA and 4 for OBESA. However, if
LISA reacts to the publication of the dossier with the public message about the lack of healthy
and cleaning measures in the production facilities of OBESA, profits would be of 3 million euros
for LISA and of only 1 for OBESA.
a) Write the equivalent normal form of Game A and find all the Nash equilibria in pure and
mixed strategies.
b) Consider Game B which is the same as Game A but now Player B observes Player A’s
choice before making his own decision. Find the pure strategy Nash equilibria of Game
B. Is there a subgame perfect Nash equilibrium in pure strategies?
c) Consider Game C which is as follows. Player A chooses between two actions α and β.
The choice of α implies payoffs of 5 and of 25 for him and Player B, respectively.
Choosing β leads to Game A. Draw the extensive form game of Game C. How many
subgames does this game have? How many information sets has each player? Calculate
the subgame perfect equilibrium/a in pure and mixed strategies.
- A torturer proposes both his prisoners a macabre game. Prisoner 1 can choose whether the
game remains at stage A or moves on to stage B. If the game remains at stage A, both prisoners
would be given a soft torture (which provides both a utility level of 2). If they move on to stage
B, both prisoners have to choose simultaneously and independently a number (integer) between 1
and 100. If the sum of these numbers is even, Prisoner 1 will receive a strong torture (which
provides him with a utility level of 1) and Prisoner 2 will not receive any torture (in which case
he receives a utility level of 3). If the sum is odd, Prisoner 2 receives a strong torture (utility 0 in
this case) and Prisoner 1 does not receive any (and receives a utility of 5).
a) Find all the Nash equilibria in pure and mixed strategies of this game. (Note that the set
of strategies can be simplified into 2 strategies, .choose an even number or an odd one.,
given that the sum of two even integers or two odd integers is an even one, and the sum
of one even integer and one odd one is an odd number).
b) Show that for Prisoner 1, the strategy which consists in remaining at stage A is strictly
dominated by the mixed strategy which consists in moving on to stage B, and then play a
Nash equilibrium in mixed strategies at stage B.
c) Calculate the subgame perfect Nash equilibria.
- Carlos and Natalia face the following situation. Natalia has to choose between two actions: S
to stop playing with Carlos, or C to continue playing with him. In case she chooses S , she gets a
payoff equal to y. In case she chooses C , they will have to play a simultaneous game where
Natalia chooses between U and D while Carlos chooses between L and R. The payoff matrix for
the simultaneous game is:
L R
U 3, 1 2, - 1
D 1, 0 4, 5
a) Find all the Nash equilibria for the simultaneous game that starts after Natalia chooses C.
b) Find Natalia’s payoffs in each of the Nash equilibria from part a).
c) Find all possible values for y such that Natalia’s first action is always C in all and each of
the subgame perfect Nash equlibria. List all the subgame perfect Nash equlibria for such
values of y.
- Two investors have put 10,000 € each in a bank. The bank has invested that money in a long
run project. After the investment matures, it is going to generate a gross return of 25,000 €.
However, in case the bank has to liquidate the investment before it, the returns will be only
15,000 €. There are two possible dates at which the investors can withdraw their money from the
bank: the date 1 is before the investment maturation, and the date 2 is after that. In each of these
dates, each investor decides whether he withdraws his money or not, without knowing the other
investor’s decision. If both withdraw the money at the date 1 (before the investment maturation),
each one gets 7,500 € and the game ends. If one withdraws at date 1 and the other doesn’t, the
first one gets 10,000 € while the other gets only 5,000 € and the game ends. Finally, if no one
withdraws at the date 1, the investment matures, and each investor has to decide whether or not
he withdraws the money at the date 2. If both withdraw at date 2, each one gets 12,500 € and the
game ends. If one withdraws and the other doesn’t, the first one gets 15,000 € while the other
gets only 10,000 €, and the game ends. If no one withdraws, the bank gives 12,500 € back for
each investor and the game ends.
a) Represent the game in the extensive form and indicate which the information sets are for
each player and the subgames of such game. Indicate how many and which are the
possible strategies for each player.
b) Find the subgame perfect Nash equilibria in pure strategies for this game.
- Consider the following game in the extensive form:
a) How many information sets has Player 1? What about Player 2? Represent the game in
the normal form. How many rationalizable strategy profiles are there? Find the pure
strategy Nash equilibria for the game. Which of them is subgame perfect?
b) Consider now that in the second time Player 1 has to choose an action, he doesn’t know
the action taken by Player 2. How many information sets has Player 1? What about
Player 2? Represent the game in the extensive form.
c) Find all the Nash equilibria in the subgames different than the whole game. Find all the
subgame perfect equilibrium for the whole game.
- Go back to Problem 18 from the list of static games, but suppose now that the game is
sequential and that neighbor 1 moves first (that is, neighbor 1 chooses first 𝑐
1
and after this
knowing 𝑐 1
neighbor 2 chooses 𝑐
2
of 2500; the other technology (combined cycle) fixed cost is 1000 and would allow them to
produce electricity at a cost of 30 per unit. The decisions taken by each of the firms will be
announced the first of May. The market demand function for power 𝑃
= 180 − 𝑄, where
𝐴
𝐵
a) Find all subgame perfect Nash equilibria in pure strategies of this game.
b) Suppose that both firms have adopted the combined cycle. The 1st of June of 2010 the
aim of Firm A will continue to be maximizing profits, but Firm B will no longer be
interested in profits but in the difference between its production and the production of
Firm A. More concretely, the new utility function of B will be given by
𝐵
𝐴
𝐵
𝐵
𝐴
2
Find the SPNE of the new game given that firm B is now the market leader, so that Firm
A observes how much Firm B chooses to produce before having to decide its own
production. How much does each firm produce in SPNE?
- Consider again problem 15. a) to discuss what a government could do if it were interested in
promoting the technological diversity in the energy sector.
- In the following bargaining game, a firm ( F ) and a syndicate ( S ) have to share the benefits
generated by their economic activity. Assume that the benefits are equal to 2 million euros. The
game has three stages. Offers are alternating between F, S and F. In each stage, the player who
has not offered how to share the benefits has the choice of accepting or rejecting the proposal
made by the other player. If she accepts the proposal, the game ends and if she rejects, in the next
stage, she will become the proposer. If the players do not reach any agreement, after the third
proposal, both of them get a zero payoff.
a) What will be agreement reached in equilibrium and in which time period will the
agreement be reach if the discount factor of both players is 𝛿 = 1 ⁄ 4?
b) What will be agreement reached in equilibrium and in which time period will the
agreement be reach if F has a discount factor 𝛿
𝐹
= 1 ⁄ 4 and S has 𝛿
𝑆
c) Compare the two agreements and try to provide an intuitive argument to support the
results you have found.
- Consider a bargaining (negotiation) game of 2 periods. In the first one, Player A offers Player
B to share 1 million Euros
, where x is the quantity that A would receive. Player B can
then choose to accept or reject A ’s proposition. If he accepts, the game is over. If he rejects, they
move on to period 2 where both have to make simultaneously an offer of share. If A proposes
(𝑥, 1 − 𝑥) and B proposes ( 1 − 𝑦, 𝑦), payoffs are (𝑥, 𝑦) if 𝑥 + 𝑦 ≤ 1 and (0, 0) otherwise.
Payoffs are discounted with the discount factor 𝛿 = 1 ⁄ 4.
a) Solve the subgame that starts when B rejects the offer. Find best reply functions of A and
B , and find the Nash equilibria of the subgame. Find the expected payoff of the
equilibrium in this subgame.
b) Find all the subgame perfect Nash equilibria.
Note: If B is indifferent between accepting and rejecting, we assume that he always
accepts.
- The firms Ford Motor and General Motors (GM) are bargaining over the selling price of
Ford’s luxury cars division, which GM is willing to buy. For Ford, the division has a value of 2
billions of euros, while it worth 4 billion euros for GM. In the first meeting, the two firms agreed
on the following bargaining procedure: in the first negotiation round one of them offers a price,
and then the other decides either to accept, in which case the negotiation is over, or to reject, and
they move to the next negotiation round. In the second round, the firm that reject the initial offer
makes a new offer that must be accepted or rejected by the other firm. But now, in case that the
offer is rejected, the negotiation ends, and both gets zero (while Ford keeps the division). We
assume that in any case where a firm is indifferent between accepting and rejecting an offer, it
accepts. Finally, the two firms give the same value for future or present payments.
a) For the case where Ford is the first to offer a price, draw the extensive form of the game,
clearly showing the information sets, the strategies and the payoffs. Find the subgame
perfect Nash equilibrium.
b) If GM starts offering the price in the first round, what price it will offer in a subgame
perfect Nash equilibrium?
Extra Exercises
- Three neighbors (Ana, Bea, Cruz) have to choose one among three projects ( a , b , c ).
Preferences are represented in the following table. Each column represents the order of
preferences of the corresponding neighbor, the preferred project being located above in each
column.
Ana Bea Cruz
a b c
b a a
c c b
The choice is realized using a simple majority rule in a two step vote. In the first step, the
neighbors choose between a and b , and the winner of this step competes against c. From this
second step is selected the project that will be implemented.
a) What would be the result if, in each step, preferences are truly revealed? (i.e., they vote
for the project they prefer).
We analyze now this election mechanism as a game (the neighbors can vote strategically)
b) Assume that a has been chosen in the first step. Explain why the fact that all neighbors
vote for c in the second stage is a Nash equilibrium.
c) Why isn’t this equilibrium very plausible? Which refinement (or selection criterion)
would eliminate this equilibrium?
d) Which subgame perfect Nash equilibrium would satisfy this refinement in both steps?
Firm 2. Given prices 𝑝
1
and 𝑝
2
, Firm 1 will be able to sell 𝑞
1
1
2
and Firm 2
will be able to sell 𝑞
2
2
1
. Both firms have marginal costs of 50.
a) Suppose the two firms move simultaneously. Find their best response functions. Find out
the Nash equilibrium of this game. Also find each firm’s profits at the equilibrium prices.
b) Suppose now Firm 1 moves first, and Firm 2 observes Firm 1’s choice of 𝑝
1
before
choosing 𝑝
2
. Find the prices, quantities and profits in the subgame perfect Nash
equilibrium.
c) Is there an advantage of moving first in this game?
- Ester and Fernando play a game where each of them have to choose a number from the
interval [0, 1]. First Ester writes a number x , x ∈ [0, 1]. Then, after observing x, Fernando
chooses a number y , y ∈ [0, 1]. Ester’s and Fernando’s utility functions are 𝑈
𝐸
(𝑥, 𝑦) = min(𝑥, 𝑦)
and 𝑈 𝐹
2
respectively.
a) Represent this game in the extensive form, indicating if it is a perfect or imperfect
information game, how many information sets each player has, and how many subgames
the game has.
b) What are Fernando’s best responses for each of the following Ester’s choices: x = 0, x
=1/4, x =1/2 and x = 1?
c) Find the subgame perfect Nash equilibrium for the game. Suppose that, in case of being
indifferent between two numbers, Fernando always chooses the greater one.
d) Find the utilities obtained by Ester and Fernando in the subgame perfect Nash
equilibrium.
- Consider the following game, where Jorge chooses between the actions A and B , while Alicia
chooses between C and D :
C D
A 2, 1 0, 0
B 0, 0 1, 2
a) Find all the Nash equilibria in pure and mixed strategies for this game. Indicate the utility
each of the players gets in each of the equilibria.
b) Suppose now that Jorge and Alicia choose their actions sequentially, with Jorge choosing
first, and Alicia being able to observe Jorge’s action before choosing her own action.
Find ALL the subgame perfect Nash equilibria for this new game. How much gets each
of the players in these equilibria?
- Consider a firm ( F ) that selects the number of workers 𝐿 ≥ 0 and a union ( U ) that fixes the
wages, 𝑤 ≥ 0. Firm’s profits are given by Π 𝐸
2
− 𝑤𝐿 whereas union’s
payoff is given by total wage, Π 𝑆
= 𝑤𝐿. Suppose that the union chooses first the wage w ,
and the firm observes w and then chooses labor input L.
a) Draw the extensive form of the game and find the subgame perfect equilibrium.
b) Suppose that the union is worried about reaching an employment level of X at least, so
that its payoff function is now
𝑆
Draw the extensive form of the game and find the subgame perfect equilibrium, as a
function of E.
- Consider the following effort-negotiation game between two partners in a joint project X. In
a first stage partners 1 and 2 must choose simultaneously the effort level, 𝑒 𝑖
∈ [0,∞) for i = 1, 2,
to exert in the joint project X. Gains from project X are:
1
2
1
2
1
2
The cost of exerting effort is given by
𝑖
1
2
𝑖
2
, for 𝑖 = 1 , 2.
In a second stage, once 𝑒 1
and 𝑒
2
have been chosen, the two partners agree to share those gains
as follows. They flip a coin and if the result is heads Partner 1 proposes a division of the gains
between him and Partner 2. The latter must decide whether to accept or reject that division. If
rejected, the game ends and both partners earn zero. If tails, the allocation procedure is the same
but Partner 2 will be the one proposing the division of gains. Find all the subgame perfect
equilibria of the game. Specify your results in terms of the strategies of each of the players
- Consider the following Extensive form game among three players
