VSE - Introduction to Game Theory

Problem set #2 - Due Tuesday, April 27, 2010 - Suggested Solution

You can work in groups of up to three people. Each group submits one copy of problem
set with the names of all members. Homework can be delivered: (1) by email to
[email protected] or (2) personally during the lecture or office hours.
No later submissions will be accepted!

Problem 1: Find all the Nash equilibria and Subgame perfect Nash equilibrium of the
game below. (When constructing the normal form of each game, be sure to include all
the strategies of each player.)

Solution: There are three NE in the game: (CH,F), (DG,E), (DH,E).

The subgame perfect NE of the game is (DG,E).

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Problem 2: Two players are repeatedly playing Matching Pennies game. Each player has
two actions: Heads (H) and Tails (T). Each round, both players simultaneously choose
their actions. After each round the observe the result of the game. How many strategies
do players have if they only play this game once? How many strategies do players have if
the game is played twice (i.e. has two rounds)? (Hint: players may condition their second
round action on the results of the first round.)

Solution: If the game is played once, each player has only two strategies: H and T.

If the game is played twice, players have 2 actions in the first round and then a plan for
an action for each possible outcome of round one. There are four possible outcomes of the
first round: both player chose H, player 1 chose H and player 2 chose T, player 1 chose
T and player 2 chose H, both players chose T. So for the second round each player has a
quadruple of actions: for example HHTH (play H in case of first, second, fourth outcome;
play T in case of third outcome). All together, each player has a strategy of this type:
H,HHTH, where the first letter is action in round one and quadruple of the letters is a
plan for the second round. There are altogether 25 strategies like this.

Problem 3: Two children use the following procedure to divide a cake. Child 1 divides
the cake into two pieces, and then child 2 chooses one of the pieces; child 1 obtains the
remaining piece. The cake is continuously divisible, and each child likes all parts of it, so
that each child cares only about the size of the piece of cake she obtains. How is the cake
divided in a subgame perfect equilibrium?

Solution: After the first child divides the cake to two parts, the second child always
chooses a bigger piece. So for the first child, the best strategy is to cut the cake in two
equal parts. Then both children get half the cake. (If the first child divides the cake to
two unequal parts, he would be worse of after getting the smaller one.)

Problem 4: Two people are involved in a dispute. Person 1 does not know whether
person 2 is strong or weak; she assigns probability to person 2s being strong. Person
2 is fully informed. Each person can either fight or yield. Each persons preferences are
represented by the expected value of a payoff function that assigns the payoff of 0 if she
yields (regardless of the other persons action) and a payoff of 1 if she fights and her
opponent yields; if both people fight then their payoffs are (-1, 1) if person 2 is strong

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and (1, -1) if person 2 is weak. Formulate this situation as a Bayesian game and find its
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Nash equilibria if (a) = 3
and if (b) = 34 .

Solution:
1\2 F Y 1\2 F Y
F -1,1 1,0 F 1,-1 1,0
Y 0,1 0,0 Y 0,1 0,0
State: strong State: weak

Now, we construct one payoff table, where for the first player we use expected payoffs,
because he faces uncertainty about second players type. Expected payoffs of the first
player if = 1/3 are as follows:

1 2 1
P2-FF: EP(F) = (1) + 1=
3 3 3
1 2 1
P2-FY: EP(F) = (1) + 1 =
3 3 3
1 2
P2-YF: EP(F) = 1+ 1=1
3 3
1 2
P2-YY: EP(F) = 1+ 1=1
3 3

Expected payoff of playing Y is always zero, irrespective of player 2s strategy.

Therefore our payoff table is below. The first number is expected payoff of the first player,
second number is the payoff of the second player if he is strong, and the third number is
the payoff of the second player if he is weak.

FF FY YF YY
1 1
F 3
,1,-1 3
,1,0 1,0,-1 1,0,0
Y 0,1,1 0,1,0 0,0,1 0,0,0

This Bayesian game has one Bayesian Nash Equilibrium: (F,FY). In this equilibrium,
first player always Fights (probability of his opponent being strong is low enough) and
the second player plays Fight if strong and Yield if weak. In this equilibrium, player one
is playing the best response given his expectations about the strength of his opponent,
and player two is playing the best response both if he is weak or strong.

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Similarly, if = 3/4 we construct new Bayesian normal-form game. The first number is
expected payoff of the first player, second number is the payoff of the second player if he
is strong, and the third number is the payoff of the second player if he is weak.

FF FY YF YY
F 12 ,1,-1 12 ,1,0 1,0,-1 1,0,0
Y 0,1,1 0,1,0 0,0,1 0,0,0
This Bayesian game has one Bayesian Nash Equilibrium: (Y,FF). In this equilibrium, first
player always Yields (probability of his opponent being strong is too big) and the second
player plays Fight no matter if he is weak or strong. In this equilibrium, player one is
playing the best response given his expectations about the strength of his opponent, and
player two is playing the best response both if he is weak or strong.

Alternatively, we can find NE of this game in the following way:

The best responses of each type of player 2 are indicated by underlined numbers. Thus
if < 1/2 then player 1s best action is fight, whereas if > 1/2 his best action is yield.
Thus for < 1/2 the game has a unique Nash equilibrium, in which player 1 chooses
fight and player 2 chooses fight if she is strong and yield if she is weak, and if > 1/2 the
game has a unique Nash equilibrium, in which player 1 chooses yield and player 2 chooses
fight whether she is strong or weak.