BITS F314: Comprehensive Examination

Time: 1hr. 50 min Total Marks: 30 Marks

Attempt all 5 questions (pp. 1-3)

Question 1:

Consider a Cournot duopoly model with inverse demand given by,

P(Q)=a-Q, where Q=q1+q2 is the aggregate quantity.
Firm 1‟s cost function is C1(q1)=cq1.
Firm 2‟s cost function is C2(q2)=cHq2 with probability 0.5 and C2(q2)=cLq2 with probability 0.5, where cL<cH.
Furthermore, information is asymmetric: firm 2 knows its cost function and firm 1‟s, but firm 1 knows its own cost
function and only that firm 2‟s marginal cost is cH with probability 0.5 and cL with probability 0.5. All of this is
common knowledge. (3+3=6)

a. Find the best response functions. (working required)

b. Find the pure strategy Bayes-Nash equilibrium to this game. (working required)

Question 2:

Consider the following game: The players are „B‟ and „C‟. There are 3 envelopes labeled: 0, 1, and 2. One of the
envelopes contains 1M$ and all the other envelopes contain zero million$. All envelopes are equally likely to
contain the 1 million$ prize (with probability 1/3). „C‟ owns envelope 0.

Period 0:
„B‟ offers a price p0, and C accepts or rejects the offer. If he accepts, then B buys the content of envelope 0 for price
p0, ending the game. (C gets p0 million$ and B gets the content of the envelope minus p0 million$).

Period 1:
If C rejects the offer in period 0, then we open envelope 1, revealing the content to both players. B again offers a
price p1, and C accepts or rejects the offer. If he accepts, then B buys the content of envelope 0 for price p1;
otherwise we open envelope 2, and the game ends with C owning the content of envelope 0 and B owning 0.
1/ 
The utility of owning x million$ is x for B and x for C, where   1. Assume  is commonly known.

(2+2+2=6)
a. Write and explain the condition when C accepts the offer in period 1.
b. How much does B offer in period 1? Explain.
c. Is B happy to make that offer in period 1? Explain.

Question 3:

a.Consider an indefinitely repeated game such that with probability p the game continues to the next period and with
prob (1-p) it ends. The “grim trigger‟” strategy is such that a player cooperates as long as the other does and defects
forever if the other player defects.
Player 2

Player Cooperate Defect

1
Cooperate 8,8 0,10

Defect 10,0 4,4

When is cooperation sustainable as a subgame perfect equilibrium by the “grim trigger” strategy? (3)

1
b.Two companies, A and B, extract oil from a common oilfield. They can choose to use the common field less or
more and the resulting strategic interaction may be described as a simultaneous-move game. The payoff matrix is
the following:

B
less more
A less 50,50 30,65
more 65,30 40,40
“In an infinitely repeated game the cooperative strategy will be preferred against a grim trigger strategy”. True or
False? Explain your argument by writing the trigger strategy when the game is repeated infinitely, the net present
value of cooperation, the net present value of deviation, and the discount factor. (3)

Question 4:

Some men are engaged in an argument. The „commoners‟ arrives to restore order, and one of the „stranger‟ acts as if
he is able to shoot his gun. The decision faced by the commoner and the stranger is whether to shoot immediately or
instead wait and shoot only in response to the other‟s pulling out his gun. The shooting talents of the commoner are
known (by reputation), but the commoner does not know the skill of the stranger. He can be a good or a bad shooter.
Hence, the commoner does not know whether he is in situation (a) or (b) below. The players assign a common prior
probability p to (a).

(3+3=6)
(a) Stranger is good shooter
stranger
shoot (S) Wait (W)
commoner shoot (S) 2,3 3,1
Wait (W) 1,4 8,2

(b) Stranger is bad shooter

stranger
shoot (S) Wait (W)
commoner shoot (S) 5,2 4,1
Wait (W) 6,3 8,4

1
Is S a best response for the commoner to (S;S) if p  ? True or False. Verify and explain.
2
4
Is W a best response for the commoner to (S;W) if p  ? True or False. Verify and explain.
5

2
Question 5

Consider the signaling game given in figure below. Explain all the pooling and separating strategies. Find all the
pure strategy pooling and separating perfect Bayesian equilibria in the signaling game and explain.
(6)

1,1 2,2
u Sender
u
t1
L R

d d
2,0 0.5 0,0

Receiver
Nature Receiver

1,0
0,0 u 0.5 u

L t2 R
d d
0,1 Sender
1,1