BE

510 Business Economics 1 - Autumn 2021

Problem Set 5

1. Player 1 and Player 2 expect to play the “normal game” (probability 0.9) but know that they
might end up in the “exceptional game” (probability 0.1).

Normal: Player 2 Exception: Player 2

Left Right Left Right
First 20 , 20 20 , 10 First 20 , 20 20 , 10
Player 1
Second 10 , 05 30 , 01 Player 1 Second 25 , 00 30 , 01
Third 05 , 05 40 , 40

In the “exceptional game” player 1 has a third option available and the payoffs for the cell
(Second, Left) change. Player 1 is informed in advance about the game’s type. Player 2 is not.
(a) Find a Bayes-Nash equilibrium.
(b) Based on equilibrium analysis, would the players prefer to live in a world in which player
2 is fully informed?

2. Reconsider the two games discussed in Problem Set 2.

A wants to meet B: Bob A wants to avoid B: Bob

Ballet Football Ballet Football
Ballet 3 , 2 1 , 1 Ballet 1 , 2 3 , 1
Alice Alice
Football 0 , 0 2 , 3 Football 2 , 0 0 , 3

Suppose now that Bob is uncertain whether Alice wants to meet or avoid him. However, it is
common knowledge that the probability of Alice wanting to meet him is 𝛼. Find the Bayes-
Nash equilibria of this game.


 BE 510 Business Economics 1 - Autumn 2021

Problem Set 5 - Solutions

No guarantees for correctness. If you find errors in the proposed solutions, please let us know.

1. Player 1 and Player 2 expect to play the “normal game” (probability 0.9) but know that they
might end up in the “exceptional game” (probability 0.1).

Normal: Player 2 Exception: Player 2

Left Right Left Right
First 20 , 20 20 , 10 First 20 , 20 20 , 10
Player 1
Second 10 , 05 30 , 01 Player 1 Second 25 , 00 30 , 01
Third 05 , 05 40 , 40

In the “exceptional game” player 1 has a third option available and the payoffs for the cell
(Second, Left) change. Player 1 is informed in advance about the game’s type. Player 2 is not.
(a) Find a Bayes-Nash equilibrium.
Since Player 1 is informed about Nature’s move, she has six pure strategies to choose from
(2 possible actions for the normal game times 3 possible actions for the exceptional
game). That is, her strategies are:
1. Choose First in the normal game and First in the exceptional game.
2. Choose First in the normal game and Second in the exceptional game.
3. Choose First in the normal game and Third in the exceptional game.
4. Choose Second in the normal game and First in the exceptional game.
5. Choose Second in the normal game and Second in the exceptional game.
6. Choose Second in the normal game and Third in the exceptional game.
Let’s refer to these strategies as (First, First), (First, Second), (First, Third), (Second,
First), (Second, Second) and (Second, Third), respectively. Player 2 only has two pure
strategies: Left and Right.
To begin our equilibrium analysis, we ask: Is there a BNE in which Player 2 chooses Left?
Note: This is an arbitrary starting point. We could just as well ask whether there is an equilibrium in which
Player 2 chooses Right. Or we could start by asking whether there is an equilibrium in which Player 1
chooses (Second, Second). It doesn’t matter so much how exactly we begin—we just must begin somewhere.
If P2 chooses Left, P1’s best response is (First, Second). But we need mutual best
responses. So, is Left a best response to (First, Second)? Well, given that P1 plays (First,
Second), P2’s expected payoff from choosing Left is 𝜋! #Left|(First, Second)6 = 0.9 ⋅ 20 +
0.1 ⋅ 0 = 18 and his expected payoff from choosing Right is 𝜋! #Right|(First, Second)6 =
0.9 ⋅ 10 + 0.1 ⋅ 1 = 9.1. Hence, Left is obviously the better choice.

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Problem Set 5 - Solutions BE 510 Business Economics 1 - Autumn 2021

Thus, we have a Bayes-Nash equilibrium where Player 1 chooses (First, Second)

and Player 2 chooses Left.
Suppose now that P2 chooses Right. P1’s best response is (Second, Third). Given that P1
plays this strategy, P2’s expected payoff from choosing Left is 𝜋! #Left|(Second, Third)6 =
0.9 ⋅ 5 + 0.1 ⋅ 5 = 5 and his payoff from choosing Right is 𝜋! #Right|(Second, Third)6 =
0.9 ⋅ 1 + 0.1 ⋅ 40 = 4.9. Thus, Left is better than Right and so there is no Bayes-Nash
Equilibrium where P2 chooses Right.
(b) Based on equilibrium analysis, would the players prefer to live in a world in which player
2 is fully informed?
In the Bayes-Nash Equilibrium solution of part (a) Player 1’s expected utility is
𝜋" #(First, Second)|Left6 = 0.9 ⋅ 20 + 0.1 ⋅ 25 = 20.5
and Player 2 expects to earn 18, as seen above.
Under complete information we can analyze each game on its own: (First, Left) is the
unique Nash Equilibrium of the normal game and (Third, Right) is the unique Nash
Equilibrium of the exceptional game. Hence, under complete information:
- Normal game: Both players earn 20 (same as under incomplete info).
- Exceptional game: Both players earn 40 (instead of 25 and 0).
The expected payoffs would be 0.9 ⋅ 20 + 0.1 ⋅ 40 = 22 for both players. Hence, yes, both
would prefer a world of complete information.

2. Reconsider the two games discussed in Problem Set 2.

A wants to meet B: Bob A wants to avoid B: Bob

Ballet Football Ballet Football
Ballet 3 , 2 1 , 1 Ballet 1 , 2 3 , 1
Alice Alice
Football 0 , 0 2 , 3 Football 2 , 0 0 , 3

Suppose now that Bob is uncertain whether Alice wants to meet or avoid him. However, it is
common knowledge that the probability of Alice wanting to meet him is 𝛼. Find the Bayes-
Nash equilibria of this game.
The extensive form of this game is shown on the next page. There are two types of Alice. Type-
1 Alice wants to meet Bob and type-2 Alice wants to avoid him.
What are the possible strategies? First Bob: He must decide without knowing Alice’s type or
which action she took. Therefore, he merely has two pure strategies to choose from: “Ballet”
and “Football”. Alice: She cannot observe Bob’s action before she makes her choice, but she is
informed about her own type. Hence, she can condition her action on her type and so she can
choose among four strategies:

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Problem Set 5 - Solutions BE 510 Business Economics 1 - Autumn 2021

1. Choose “Ballet” when she is of type 1 and choose “Ballet” when she is of type 2.
2. Choose “Ballet” when she is of type 1 and choose “Football” when she is of type 2.
3. Choose “Football” when she is of type 1 and choose “Ballet” when she is of type 2.
4. Choose “Football” when she is of type 1 and choose “Football” when she is of type 2.
Let’s refer to these four strategies as BB, BF, FB, and FF, respectively.

let
Bal 3, 2
t Bob
lle
Ba Foo 1, 1
tie
Alice 1
𝛼]
[ Fo let 0, 0
ob ot Bal
et B ie Bob
e
M Foo
tie 2, 3
Nature
Av let
oi Bal 1, 2
d B t Bob
ob lle
[1 Ba Foo
tie 3, 1
−
𝛼] Alice 2

Fo let 2, 0
ot Bal
ie Bob
Foo 0, 3
tie

Alice’s best responses
To find the equilibria, consider Alice’s best responses to Bob’s choices. Given that Bob chooses
Football, Alice 1 will strictly prefer Football to Ballet, but Alice 2 will strictly prefer Ballet to
Football. Thus, her best response to Football is FB. Given that Bob chooses Ballet, Alice 1
will strictly prefer Ballet to Football and Alice 2 will strictly prefer Football to Ballet. Thus,
her best response to Ballet is BF.

Bob’s payoffs given Alice’s best responses

What are Bob’s payoffs given FB and given BF? Given that she plays FB: If he plays Ballet, he
will be alone at the ballet performance and earn 0 if she is of type 1 but he will meet her and
earn 2 if she is of type 2. Hence:
𝜋Bob (Ballet|FB) = 𝛼 ⋅ 0 + (1 − 𝛼) ⋅ 2 = 2 − 2𝛼.
If he plays Football, he will meet her and earn 3 if she is of type 1 but he will be alone at the
football stadium and earn 1 if she is of type 2. Hence:
𝜋Bob (Football|FB) = 𝛼 ⋅ 3 + (1 − 𝛼) ⋅ 1 = 1 + 2𝛼.
Given that she plays BF: If he plays Ballet, he will meet her and earn 2 if she is of type 1 but he
will be attending the ballet performance on his own and earn 0 if she is of type 2. Hence:
𝜋Bob (Ballet|BF) = 𝛼 ⋅ 2 + (1 − 𝛼) ⋅ 0 = 2𝛼.

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Problem Set 5 - Solutions BE 510 Business Economics 1 - Autumn 2021

If he plays Football, he will be alone at the football stadium and earn 1 if she is of type 1 but
he will meet her and earn 3 if she is of type 2. Hence:
𝜋Bob (Football|BF) = 𝛼 ⋅ 1 + (1 − 𝛼) ⋅ 3 = 3 − 2𝛼.

Mutual best responses

As we have seen, Alice’s best response to Football is FB. Conversely, Bob’s best response to
FB is Football if 1 + 2𝛼 ≥ 2 − 2𝛼 or 𝛼 ≥ 1⁄4. Alice’s best response to Ballet is BF. Conversely,
Bob’s best response to BF is Ballet if 2𝛼 ≥ 3 − 2𝛼 or 𝛼 ≥ 3⁄4. Thus, intuitively, in both cases
Bob matches the choice of type-1 Alice if it is sufficiently likely that the Alice he faces is the
type-1 Alice. In the case of Football, a relatively smaller probability is sufficient than in the
case of Ballet because Football generally yields larger payoffs to Bob than Ballet. But when it
becomes sufficiently likely that Alice is of type 2 Bob’s best response is to match the choice of
type 2 Alice.
In summary: If 𝜶 ≥ 𝟑⁄𝟒 there are two pure-strategy Bayes-Nash equilibria: (1) Alice
chooses FB and Bob chooses Football. (2) Alice chooses BF and Bob chooses Ballet. If
𝜶 < 𝟑⁄𝟒 equilibrium (2) disappears. If 𝜶 < 𝟏⁄𝟒 equilibrium (1) also disappears. That
is, for 𝜶 < 𝟏⁄𝟒 there is no pure-strategy Bayes-Nash equilibrium. This is not a big
surprise. In Problem Set 3 – Question 2 we have already seen that there is no pure-strategy
Nash equilibrium when 𝛼 = 0, i.e. when it is certain that Alice seeks to avoid Bob. Note that in
any pure-strategy equilibrium Bob meets Alice if and only if Alice wants to meet him.