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Ps 4 Solution

This document provides a solution to a dynamic game problem using backward induction. It analyzes the objectives and constraints of both the parent and child at different stages. The solution shows that maximizing the individual objectives of parent and child leads to the same outcome as jointly maximizing their total income, satisfying the first-order condition of their combined income maximization problem.

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Aparna Howlader
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87 views

Ps 4 Solution

This document provides a solution to a dynamic game problem using backward induction. It analyzes the objectives and constraints of both the parent and child at different stages. The solution shows that maximizing the individual objectives of parent and child leads to the same outcome as jointly maximizing their total income, satisfying the first-order condition of their combined income maximization problem.

Uploaded by

Aparna Howlader
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Problem Set 4 Solution

17.881/882 October 26, 2004

Gibbons 2.1 (p.130)

This is a dynamic game of perfect information, we will use backward induction to solve. We start at the nal stage. The parents objective is max V (Ip (A) B ) + kU (Ic (A) + B )
B

The rst-order condition is: V 0 (Ip (A) B ) + kU 0 (Ic (A) + B ) = 0 (1)

(Ill omit discussion of the second-order condition). This equation is dening an implicit relation B (A). In the rst stage, the child anticipates his choice of A to aect B according to 1. The childs problem is max U (Ic (A) + B (A))
A

The rst-order condition is:


0 (A) + B 0 (A)] = 0 U 0 (Ic (A) + B )[Ic

(2)

(Ill omit discussion of the second-order condition). Since U 0 > 0, the only way for 2 to hold is to have
0 Ic (A) = B 0 (A)

(3)

To nd B 0 (A), let us use the implicit function theorem on 1.


00 0 V 00 Ip + kU 00 Ic dB = dA V 00 + kU 00

0 Using 3, and solving for Ic , we nd 0 0 V 00 [Ic (A) + Ip (A)] = 0 0 0 Since V is strictly concave, this can only hold if Ic (A) + Ip (A) = 0, which is exactly the rst-order condition of the joint-income maximization problem:

max Ic (A) + Ip (A)


A

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