ASSIGNMENT 4

1. Consider the following extensive form game. Firm A decides whether to enter Firm B’s
industry. Firm B observes this decision. If firm A enters, then the two firms
simultaneously decide whether to advertise. Otherwise, firm B alone decides whether
to advertise. With two firms in the market, the firms earn $4 million each if they both
advertise and $6 million if they do not. If only one firm advertises, it earns $7 million;
the other earns $2 million. When firm B is solely in the industry, it earns $5 million if
it advertises and $4.5 million if it does not advertise. Firm A earns nothing if it does not
enter. How many subgames this game has?
a. 2
b. 3
c. 5
d. 1
Answer – (b)
Firm A decides whether to enter the market or not. This is the initial decision node and
represents the start of the game. If Firm A enters the market, Firm B observes this and
then both firms simultaneously decide whether to advertise or not. This decision point
is where a subgame begins. If Firm A does not enter the market, Firm B alone decides
whether to advertise. This is another subgame, independent of what happens if A enters
the market. The entire game itself is a subgame. Thus, there are 3 subgames in total,
including the game itself.
2. Consider the following extensive form game:

How many Nash Equilibria this game has?

a) 4
b) 3
c) 5
d) 2
Answer – (a)
To find out the no. of NEs in this game you need to formulate a game table in normal
form. The strategies for player P1 will be: {A, B, C, D}, and the strategies for player
 P2 will be: {EEE, EEF, EFE, FEE, FFF, FEF, EFF, FFE}. Accordingly, there will be 4
NEs. The payoff table can be represented as:
EEE EEF EFE FEE FFF FEF EFF FFE
A 3,1 3,1 3,1 0,0 0,0 0,0 3,1 0,0
B 2,2 2,2 2,2 1,1 1,1 1,1 2,2 1,1
C 3,6 3,6 3,6 4,8 4,8 4,8 3,6 4,8
D 6,1 6,1 6,1 7,9 7,9 7,9 6,1 7,9
The NEs are marked in red.
3. Consider the following extensive form game:

Which of the following is(are) NE(s) of this game?

a) (D,FEE)
b) (D,FEF)
c) (D,FFF)
d) All of the above
Answer – (d)
4. Consider the following extensive form game:

How many Subgame Perfect Nash Equilibria (SPNE) this game has?
a) 2
 b) 1
c) 0
d) Can’t be determined
Answer – (b)
To determine the number of Subgame Perfect Nash Equilibria (SPNE) in the game, we
need to evaluate the game using backward induction. SPNE are Nash equilibria where
players' strategies constitute a Nash equilibrium in every subgame of the original game.
This game has only one SPNE in which. This is because out of the 4 NEs, there is only
1 NE which satisfies the rationality assumption.
5. In the "burning the bridge" example in game theory discussed in one of the lectures,
what strategic advantage does Army A gain by burning the bridge after crossing it?
a. It demonstrates to Army B that they are willing to negotiate.
b. It shows Army B that they have no choice but to retreat.
c. It signals to Army B that they are fully committed to the battle, thus increasing
the cost for Army B to engage in a fight.
d. It allows Army A to secure a safe retreat in case of defeat.
Answer – (c)
By burning the bridge after crossing it, Army A signals to Army B that they have no
option to retreat and are fully committed to the battle. This action can create a
psychological advantage because it increases the perceived cost for Army B to engage
in a fight. Army B might reconsider the confrontation, knowing that Army A is
committed and has no alternative but to fight to the end.
6. In the ultimatum game, why might a proposer offer more than the minimal amount to
the responder?
a. The proposer wants to maximize their own payoff by keeping as much as
possible.
b. The proposer is trying to avoid rejection by making a fairer offer.
c. The proposer does not understand the rules of the game.
d. The proposer believes the responder will reject any offer, regardless of the
amount.
Answer – (b)
In the ultimatum game, the proposer might offer more than the minimal amount to the
responder primarily to avoid the risk of having the offer rejected. If the responder rejects
the offer, both players get nothing, so the proposer has an incentive to make the offer
appear fair enough to ensure that the responder accepts it.
7. In the context of oligopolistic competition, which of the following models illustrates
the concept of first-mover advantage?
a. Cournot model
b. Bertrand model
c. Stackelberg model
d. Hotelling model
 Answer – (c)
In the context of oligopolistic competition, the Stackelberg model illustrates the concept
of first-mover advantage. In the Stackelberg model, one firm (the leader) moves first
and makes a decision (such as setting the quantity of output), and then the other firm
(the follower) makes its decision after observing the leader's choice. The leader can
strategically choose its output level to maximize its advantage, knowing that the
follower will react to it.
8. Initially there is one firm in a market for cars. The firm has a linear cost function: C(q)
= 3q. The market inverse demand function is given by P (Q) = 7 −2Q. A second firm
enters the market and has an identical cost function. The Stackelberg Equilibrium
output for both firms are (First firm moves first)
a) (1/2,1/2)
b) (1,1)
c) (1,1/2)
d) (1/2,1)
Answer – (c)
To find the Stackelberg Equilibrium outputs for both firms, we need to analyze the
situation step by step. In the Stackelberg model, the first firm (the leader) chooses its
output level first, and the second firm (the follower) reacts to this choice.
The inverse demand function is:
𝑃(𝑄) = 7 − 2(𝑞1 + 𝑞2 )
The profit function for firm 2 is:
𝜋2 = 4𝑞2 − 2𝑞1 𝑞2 − 2𝑞22
To maximize the profit, we need to differentiate 𝜋2 w.r.t 𝑞2 and set it equal to 0 as 𝑞1
has been assumed to be fixed. Upon optimizing, the reaction function of the follower
i.e., firm 2 will be:
1 𝑞1
𝑞2 = −
2 2
Now, firm 1 which is the leader knows that firm 2 will react according to this reaction
function. So, firm 1 maximizes its profit taking this into account. Upon substituting the
reaction function of firm 2 in firm 1’s profit function, we get:
𝜋1 = 3𝑞1 − 𝑞12
Taking the derivative of 𝜋1 w.r.t 𝑞1 and setting it equal to 0, we get:
𝑞1 = 1
Substituting this value in the reaction function of firm 2, we get
𝑞2 = 1/2

9. Which scenario best illustrates the application of the ultimatum game?

a) A seller and buyer negotiate the price of a car with potential counteroffers.
b) Two companies agree to equally split project profits before starting.
c) An employer makes a salary offer, and the candidate can accept or counter.
 d) One friend proposes a lottery prize split, and the other can accept or reject it,
with rejection resulting in nothing for both.
Answer – (d)
In the ultimatum game, one party (the proposer) makes an offer on how to split a certain
amount of money, and the other party (the responder) can either accept or reject the
offer. If the responder rejects the offer, both parties get nothing. This scenario closely
aligns with the dynamics of the ultimatum game.
10. The statement “Every subgame perfect equilibrium is a Nash equilibrium.”
a) Is always true
b) Is never true
c) Can be true
d) There is no relationship between Nash Equilibrium and Subgame Perfect
Equilibrium
Answer – (a)

The statement "Every subgame perfect equilibrium is a Nash equilibrium" is always

true. This is because a Subgame Perfect Equilibrium (SPNE) refines the concept of
Nash Equilibrium by requiring that the strategies form a Nash Equilibrium not only in
the entire game but also in every subgame. Therefore, any strategy profile that is a
SPNE must also satisfy the conditions of a Nash Equilibrium in the whole game.