40.
316: Game Theory Summer 2021
Homework 1 Solutions
Question 1: Each of two players has two possible actions, Quiet and Fink ; each action pair
results in the players’ receiving amounts of money equal to the numbers corresponding to
that action pair in the following game matrix:
Quiet F ink
Quiet 2, 2 0, 3
F ink 3, 0 1, 1
For example, if player 1 chooses Quiet and player 2 chooses Fink, then player 1 receives
nothing, whereas player 2 receives $3.
The players are not “selfish”; rather the preferences of each player i are represented by the
payoff function mi (a) + αmj (a), where mi (a) is the amount of money received by player i
when the action profile is a, j is the other player, and α is a given non-negative number.
Player 1’s payoff to the action pair (Quiet,Quiet), for example, is 2 + 2α.
(a) Formulate a strategic game that models this situation in the case α = 1. Is this game
the Prisoner’s Dilemma?
The payoff matrix is as follows:
Quiet F ink
Quiet 2 + 2α, 2 + 2α 0 + 3α, 3
F ink 3, 0 + 3α 1 + α, 1 + α
If α = 1, this becomes
Quiet F ink
Quiet 4, 4 3, 3
F ink 3, 3 2, 2
which is not the Prisoners’ Dilemma.
(b) Find the range of values of α for which the resulting game is the Prisoner’s Dilemma.
For this game to be the same as the Prisoners’ Dilemma, for both players i = 1, 2, we
should have ui (F ink, Quiet) > ui (Quiet, Quiet) > ui (F ink, F ink) > ui (Quiet, F ink).
This gives us:
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40.316: Game Theory Summer 2021
3 > 2 + 2α > 1 + α > 3α
which is satisfied (for non-negative α) if α < 1/2.
Question 2: Two players (player 1 and player 2) are bargaining over how to split one dol-
lar. Both of them simultaneously name shares they would like to have, s1 and s2 , where
0 ≤ s1 , s2 ≤ 1. If s1 + s2 ≤ 1, then the players receive the shares they named; if s1 + s2 > 1,
then both players receive zero. What are the pure strategy Nash equilibria of this game?
Player 1’s problem is to maximize s1 subject to s1 + s2 ≤ 1, s1 , s2 ≥ 0. Similarly, player 2’s
problem is to maximize s2 subject to s1 + s2 ≤ 1, s1 , s2 ≥ 0.
Then the set of Nash equilibria is given by {(s∗1 , s∗2 ) : s∗1 + s∗2 = 1, s∗1 ≥ 0, s∗2 ≥ 0}.
In addition, (1, 1) is also a Nash equilibrium.
Question 3: Two candidates are competing in a political race. Each candidate i can spend
si ≥ 0 on ads which affect the probability of winning the election. Given a strategy profile
(s1 , s2 ), candidate 1 wins the election with probability
s1
s1 + s2
and candidate 2 wins with probability
s2
.
s1 + s2
If both candidates spend zero, then each wins with probability one half. The payoff to
candidate i is the probability of winning minus the amount spent on ads.
(a) Write an expression for the payoff function of candidate 1.
s1
The payoff function is: s1 +s2
− s1 .
(b) Solve for the best response function of each candidate.
To find candidate 1’s best response function, differentiate his payoff with respect to s1
(taking s2 as given), set the expression equal to 0 and solve for s1 . Using quotient rule,
we have:
(s1 + s2 ) − s1
−1=0
(s1 + s2 )2
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40.316: Game Theory Summer 2021
We have:
s2 = (s1 + s2 )2
√
Then, BR1 = s2 − s2 . Similarly, you can calculate candidate 2’s best reponse:
√
BR2 = s1 − s1 .
(c) Find the pure strategy Nash equilibrium.
To find the pure strategy Nash equilibrium, we need to solve the two best response
functions simultaneously. Then, we have:
s1 = 4(s1 )2 & s1 = s2
This has two solutions, 0 and 41 . The profile (0, 0) is not a Nash equilibrium because
either candidate should instead choose a positive expenditure and receive a higher
payoff, so the only pure strategy Nash equilibrium is ( 14 , 14 ). That is, s1 = 1
4
and
s2 = 14 .
Question 4: An employer hires an employee and promises him wage w. The employee can
work (W ) or shirk (S). Working is associated with cost of effort, e, where w > e > 0. If the
employee works, the employer obtains revenue r and otherwise 2r .
Employer cannot tell whether the employee is working or shirking unless she chooses to run
inspection (I) at a cost of c > 0. Inspection reveals whether the employee is working or
not and in the latter case the wage is withheld. The decisions of the two players (W/S and
I/N I) are taken simultaneously. The payoff matrix is as follows:
I NI
W w-e, r-c-w w-e,r-w
S 0,r/2-c w,r/2-w
Employee is choosing a row (row player) and the employer is choosing a column (column
player).
(a) Under what condition(s) will this game have a pure strategy Nash equilibrium?
Given c > 0, the only possibility for a pure strategy Nash equilibrium is (S, N I). This
happens if c ≥ w.
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40.316: Game Theory Summer 2021
(b) Assume the aforementioned condition(s) is (are) not satisfied. Derive the formulas for
probability of working, p and probability of inspection, q in the mixed strategy Nash
equilibrium.
To find q equalize employee’s expected payoff from working and shirking: q(w − e) +
e
(1 − q)(w − e) = (1 − q)w. This will give: q = w
. Similarly, equalize employer’s
expected payoff from Inspection and No Inspection:
p(r − c − w) + (1 − p)(r/2 − c) = p(r − w) + (1 − p)(r/2 − w)
This gives: p = 1 − wc .
Question 5: Consider the Cournot’s game with n number of firms. Assume that the inverse
demand function is given by:
P (Q) = max{α − Q, 0},
where α > 0. The cost function of each firm i is C(qi ) = cqi for all qi , with 0 ≤ c ≤ α. As-
suming that all firms produce the same output in Nash equilibrium, solve for the equilibrium
output for each firm. Find the market price at which output is sold. Does the equilibrium
price increase or decrease as n increases?
The best response of firm 1 is:
b1 (q2 , ...qn ) = arg max q1 (α − c − q1 − q2 − ... − qn ) given q1 + ... + qn ≤ α
q1
There are n equations in the conditions for Nash equilibrium:
q1∗ = b1 (q2∗ , ...qn∗ )
q2∗ = b2 (q1∗ , ...qn∗ )
.........................
qn∗ = bn (q1∗ , ...qn−1
∗
)
which becomes (setting Q = q1 + q2 + ... + qn ) for each firm i:
1
qi∗ = (α − c − Q + qi )
2
Solving the system of equations, we get:
n α−c α n
Total output, Q = n+1
(α − c) and qi = n+1
. Market price is given by α − Q = n+1
+ n+1
c.
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40.316: Game Theory Summer 2021
As n → ∞, the first term goes to 0 and the second term goes to c. Therefore, as the number
of firms becomes very large, the Nash equilibrium becomes the same as the outcome of price
equaling marginal cost.
Question 6: Two people can perform a task if, and only if, they both exert effort. They
are both better off if they both exert effort and perform the task than if neither exerts effort
(and nothing is accomplished); the worst outcome for each person is that she exerts effort
and the other person does not (in which case again nothing is accomplished). Specifically,
the players’ preferences are represented by the expected value of the payoff functions in the
following figure (where c is a positive number less than 1 that can be interpreted as the cost
of exerting effort):
No effort Effort
No effort 0, 0 0, −c
Effort −c, 0 1 − c, 1 − c
Find all the mixed strategy Nash equilibria of the game. How do the equilibria change as c
increases?
Apart from the two pure strategy equilibria (N E, N E) and (E, E), there is one mixed
strategy equilibrium ((1 − c, c), (1 − c, c)). A change in c does not affect the players’ ranking
of the four outcomes, so the pure strategy equilibria are not affected. However, since the
probability that players will exert effort is precisely c, an increase of this variable increases
the probability that players will coordinate.
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