Problem Set 8 - Graduate Microeconomics II
Prof. Leandro Arozamena
TA: Matías Cersosimo
2017
Exercise 1 (M.W.G. 8.D.5)B
Consumers are uniformly distributed along a boardwalk that is 1 mile long. Ice-cream prices are regulated,
so consumers go to the nearest vendor because they dislike walking (assume that at the regulated prices all
consumers will purchase an ice-cream even if they have to walk a full mile). If more than one vendor is at
the same location, they split the business evenly.
(a) Consider a game in which two ice-cream vendors pick their locations simultaneously. Show that there
exists a unique pure strategy Nash equilibrium and that it involves both vendors locating at the
midpoint of the boardwalk.
(b) Show that with three vendors, no pure strategy Nash equilibrium exists.
Exercise 2 (M.W.G. 8.D.8)C
Consider a simultaneous-move game with normal form [I, {∆ (Si )} , {ui (·)}]. Suppose that, for all i, Si is a
convex set and ui (·) is strictly quasiconcave. Argue that any mixed strategy Nash equilibrium of this game
must be degenerate, with each player playing a single pure strategy with probability 1.
Exercise 3 (M.W.G. 9.B.14)B
At time 0, an incumbent rm ( rm I) is already in the widget market, and a potential entrant ( rm E) is
considering entry. In order to enter, rm E must incur a cost of K > 0, Firm E's only opportunity to enter
is at time 0. There are three production periods. In any period in which both rms are active in the market,
the following game is played:
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Firm E moves rst, deciding whether to stay in or exit the market. If it stays in, rm I decides whether to
ght (the upper payo is for rm E). Once rm E plays "out", it is out of the market forever; rm E earns
zero in any period during which it is out of the market, and rm 1 earns x. The discount factor for both
rms is δ . Assume that:
1. x > z > y .
2. y + δx > (1 + δ) z .
3. 1 + δ > K .
(a) What is the (unique) subgame perfect Nash equilibrium of this game?
(b) Suppose now that rm E faces a nancial constraint. In particular, if rm I ghts once against rm E
(in any period), rm E will be forced out of the market from that point on. Now what is the (unique)
subgame perfect Nash equilibrium of this game? (If the answer depends on the values of parameters
beyond the three assumptions, indicate how.)
Exercise 4 (F.T. 3.3)*
Pleyer 1, the "government", wishes to in uence the choice of player 2. Player 2 chooses an action a2 ∈ A2 =
{0, 1} and receives a transfer t ∈ T = {0, 1} from the government, which observes a2 . Player 2's objective is
to maximize the expected value of his transfer, minus the cost of his action, which is 0 for a2 = 0 and 12 for
a2 = 1. Player 1's objective is to minimize the sum 2 (a2 − 1) + t. Before player 2 chooses his action, the
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government can announce a transfer rule t (a2 ).
(a) Draw the extensive form for the case where the government's announcement is not binding and has no
eect on payos.
(b) Draw the extensive form for the case where the government is constrained to implement the transfer
rule it announced.
(c) Give the strategic forms for both games.
(d) Characterize the subgame-perfect equilibria of the two games.
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Exercise 5 (F.T. 3.6)*
There are two players, a seller and a buyer, and two dates. At date 1, the seller chooses his investment level
I ≥ 0 at cost I . At date 2, the seller may sell one unit of a good and the seller has cost c (I) of supplying
it, where c0 (0) = −∞, c0 < 0, c00 > 0, and c (0) is less than the buyer's valuation. There is no discounting,
so the socially optimal level of investment, I ? , is given by 1 + c0 (I ? ) = 0.
(a) Suppose that at date 2 the buyer observes the investment I and makes a take-ot-or-leave-it oer to the
seller. What is this oer? What is the perfect equilibrium of the game?
(b) Can you think of a contractual way of avoiding the ine cient outcome of (a)? (Assume that contracts
cannot be written on the level of I .)
Exercise 6 (F.T. 3.11)*
Consider the agenda-setter model of Romer and Rosenthal (1978) (see also Shepsle 1981). The object of the
game is to make a one-dimensional decision. There are two players. The "agenda-setter" (player 1, who may
stand for a committee in a closed-rule voting system) ofers a point s1 ∈ R. The "voter" (player 2, who may
stand for the median voter in the legislature) can then accept s1 or refuse it; in the latter case, the decision
is the status quo or reversion point s0 . Thus, s2 ∈ {s0 , s1 }. The adopted policy is thus s2 . The voter has
quadratic preferences − (s2 − ŝ2 )2 , where ŝ2 is his bliss point.
(a) Suppose that the agenda setter's objective is s2 (she prefers higher policy levels). Show that, in perfect
equilibrium, the setter oers s1 = s0 if s0 ≥ ŝ2 and s1 = 2ŝ2 − s0 if s0 < ŝ2 .
(b) Suppose that the agenda setter's objective function is quadratic as well: − (s2 − ŝ1 )2 . Fixing ŝ1 and
ŝ2 (ŝ1 ≷ ŝ2 ), depict how the perfect equilibrium policy varies with the reversion s0 .