Problem Set 10 - Graduate Microeconomics II

Prof. Leandro Arozamena

TA: Matías Cersosimo

2017

Exercise 1 (M.W.G. 12.D.1)B

Consider an innitely repeated Bertrand duopoly with discount factor δ < 1. Determine the conditions
under which strategies of the form in (12.D.1) sustain the monopoly price in each of the following cases:

(a) Market demand in period t is xt (p) = γ t x (p) where γ > 0.

(b) At the end of each period, the market ceases to exist with probability γ .
(c) It takes K periods to respond to a deviation.

Strategies of (12.D.1) for rm j = 1, 2:

pm if all elements of Ht−1 equal (pm , pm ) or t = 1.

pjt (Ht−1 ) =
c otherwise.

where Ht−1 is the history of all past price choices by the two rms, Ht−1 = {p1t , p2t }t−1
t=1 .

Exercise 2 (M.W.G. 12.D.3)B

Consider an innitely repeated Cournot duopoly with discount factor δ < 1, unit costs of c > 0, and inverse
demand function p (q) = a − bq , with a > c and b > 0.

 
(a) Under what conditions can the symmetric joint monopoly outputs (q1 , q2 ) = qm qm
2 , 2 be sustained
 
with strategies that call for q2 , q2 to be played if no one has yet deviated and for the single-period
m m

Cournot (Nash) equilibrium to be played otherwise?

(b) Derive the minimal level of δ such that output levels (q1 , q2 ) = (q, q) with q ∈ a−c , a−c are



2b b
sustainable through Nash reversion strategies. Show that this level of δ , δ (q), in an increasing, dier-
entiable function of q .

1
Exercise 3 (M.W.G. 12.D.4)B

Consider an innitely repeated Bertrand oligopoly with discount factor δ ∈ .

1

2, 1

(a) If the cost of production changes, what happens to the most protable price that can be sustained?
(b) Suppose, instead, that the cost of production will increase permanently in period 2 (i.2., from period
2 on, it will be higher than in period 1). What eect does this have on the maximal price that can be
sustained in period 1?

Exercise 4 (F.T. 4.1(a))**

Stationary War of Attrition

In the discrete-time version of the stationary war of attrition, two animals are ghting for a prize whose
current value at any time t = 0, 1, . . . is v > 1; ghting costs 1 unit per period. If one animal stops ghting
in period t, his opponent wins the prize without incurring a ghting cost that period, and the choice of the
second stopping time is irrelevant. If we introduce a per-period discount factor δ , the (symmetric) payo
functions are:
  1 − δ t̂
L t̂ = − 1 + δ + · · · + δ t̂−1 = −


1−δ
and  
F t̂ = − 1 + δ + · · · + δ t̂−1 + δ t̂ v = L t̂ + δ t̂ v

If both animals stop simultaneously, we specify that neither wins the prize, so that:




B1 t̂ = B2 t̂ = L t̂

Consider the following modication of the stationary symmetric war of attrition developed in subsection
1−δ , F t̂ = L t̂ + δ v , and B t̂ = L t̂ + δ qv , with q ≤ 2 , which corresponds to the
4.5.2: L t̂ = − 1−δ
t̂
1



t̂


t̂

assumption that if both animals stop ghting simultaneously the each has probability q of winning the prize.
Characterize the symmetric stationary equilibrium. Compute the limit as the time period shrinks and show
it is independent of q .

Exercise 5 (F.T. 5.1)*

Compute the set of feasible payos in the "battle of the sexes" stage game as shown in gure 1.10a. What is
the highest feasible symmetric payo? Let δ = 109
, and nd a deterministic strategy prole for the repeated
game with payos 2 , 2 .
3 3

Her
B F
F (0, 0) (2, 1)
Him
B (1, 2) (0, 0)

2
Exercise 6 (F.T. 5.9)*

Consider innitely repeated play of the stage game of gure 5.7:

Player 2
L M R
U (6, 0) (−1, −100) (0, 1)
Player 1
D (2, 2) (0, 3) (1, 1)

(a) What is the highest perfect equilibrium for player 1 if both sides are long-run players?
(b) If player 1 could publicly commit to alwats play the same mixed strategy α1 , what α1 would he choose?
What would his payo be?
(c) Show that when the player 2's are an innite sequence of short-run players the highest payo for player
1 in any Nash equilibrium is 2. To do this, proceed as follows:
• Let v ? (δ) be the supremum of player 1's payo in any Nash equilibrium when his discount factor
?
is δ , and suppose v ? (δ) > 2. Let ε = (1−δ)(v2 (δ)−2) , and choose an equilibrium σ where player 1's
equilibrium payo v (δ) is at least v ? (δ) − ε. Show that under prole σ player 1's expected payo
in the rst period must be greater than 2. (Hint: Player 1's continuation payo from the second
period on cannot exceed v ? (δ).)
• Show that under σ player 2 must play L with positive probability in the rst period, and thus
that player 1 must play D with positive probability in the rst period.
• Conclude that v ? (δ) − ε ≤ v (δ) ≤ 2 (1 − δ) + δv ? (δ), so that v ? (δ) ≤ 2.