University Carlos III of Madrid Departament of Economics

Game Theory: Problem set 5: Bayesian Games. Solutions.

Problem 1: Consider a Cornout duopoly which operates in a market with the following inverse demand
function (
90 − Q if Q ≤ 90,
P (Q) =
0 if Q > 90.
where Q = q1 + q2 is the total output in the market. The cost of firm 2 is c2 (q2 ) = 9q2 with probability
1/3 and c2 (q2 ) = 27q2 with probability 2/3. The cost of firm 1 is c1 (q1 ) = 18q1 . Firm 2 knows its own
cost, but firm 1 only knows the types of costs of firm 2 and its probabilities. The above description is
common knowledge.

1. Represent the above situation as a Bayesian Game. That is, describe the set set of players, their
types, the set of strategies, their beliefs and their utilities.
Solution: There are two players, N = {1, 2}. Their types are T1 = {r}, T2 = {cl , ch } where cl
represents the situation when firm 2 knows that its marginal cost is cl = 9 and ch represents the
situation when firm 2 knows that its marginal cost is ch = 27. The sets of strategies are S1 = [0, ∞)
and S2 = [0, ∞) × [0, ∞) = {(sl , sh ) : sl , sh ∈ [0, ∞)}. Here sl (resp. sh ) represents the strategy of
firm 2 when it knows that its marginal cost is cl = 9 (resp. ch = 27). The beliefs of the players are
1 2
p1 (cl |r) = ; p1 (ch |r) = , p2 (r|al ) = p2 (r|ah ) = 1
3 3
The utilities of the players are the following.
2 1
u1 (q1 , ql , qh |r) = (72 − q1 − qh )q1 + (72 − q1 − ql )q1
3 3
ul (q1 , ql |cl ) = (81 − q1 − ql )ql
uh (q1 , qh |ch ) = (63 − q1 − qh )qh

2. Compute the Bayesian Equilibrium and the benefits of the firms in this equilibrium.
Solution: The best response of type cl firm 2 is the solution of the following maximization problem

max ql (81 − q1 − ql )
ql

The solution is
81 − q1
ql = (0.1)
2
The best response of type ch firm 2 is the solution of the following maximization problem

max qh (63 − q1 − qh )
qh

The solution is
63 − q1
qh = (0.2)
2
The best response of firm 1 is the solution of the following maximization problem
1 2
max (72 − q1 − ql ) q1 + (72 − q1 − qh ) q1
q1 3 3
The solution is
216 − ql − 2qh
q1 = (0.3)
6

1
 The Bayesian–Nash equilibrium is the solution to equations (0.1), (0.2) and (0.3). We obtain,

q1∗ = 25, ql∗ = 28, qh∗ = 19

The benefits are,

Π∗1 = 625 Π∗l = 784 Π∗h = 361

3. Suppose now that firm 1 knows that the costs of firm 2 is c2 (q2 ) = 9q2 . Compute the Nash
equilibrium and the benefits of the firms in this equilibrium.
Solution: The best response of type cl firm 2 is the solution of the following maximization problem

max ql (81 − q1 − ql )
ql

The solution is
81 − q1
ql = (0.4)
2
The best response of firm 1 is the solution of the following maximization problem

max (72 − q1 − ql ) q1
q1

The solution is
72 − ql
q1 = (0.5)
2
The Bayesian–Nash equilibrium is the solution to equations (0.4) and (0.5). We obtain,

q̄1 = 21, q̄l = 30

The benefits are,

Π̄1 = 441 Π̄l = 900

4. Suppose now that firm 1 knows that the costs of firm 2 is c2 (q2 ) = 27q2 . Compute the Nash
equilibrium and the benefits of the firms in this equilibrium.
Solution: The best response of type ch firm 2 is the solution of the following maximization problem

max qh (63 − q1 − qh )
qh

The solution is
63 − q1
qh = (0.6)
2
The best response of firm 1 is
72 − qh
q1 =
2
The Bayesian–Nash equilibrium is the solution to equations (0.4) and (0.6). We obtain,

q̃1 = 27, q̃h = 18

The benefits are,

Π̃1 = 729 Π̃h = 324

5. In view of the above computation there is one type of firm 2 which prefers complete information
and one type that prefers the situation with incomplete information. Identify those types.
Solution: Type cl of firm 2 produces ql = 28 and obtains a profit of Πl = 784 with incomplete
information and produces ql = 30 and obtains a profit of Πl = 900 with complete information. It

2
 prefers the situation with complete information. This firm would benefit if it could credibly inform
firm 1 that the the cost of firm 2 is low cl .
Type ch of firm 2 produces qh = 19 and obtains a profit of Πh = 361 with incomplete information
and produces qh = 18 and obtains a profit of Πh = 324 with complete information. It prefers the
situation with incomplete information. This firm prefers that firm 1 is either not informed or (even
better) that firm 1 believes (wrongly) that the the cost of firm 2 is low cl .
Finally, firm 1 prefers the situation with incomplete information when it faces firm 2 with cost cl .
And it prefers the situation with complete information when it faces firm 2 with cost ch .

Complete information cl Incomplete information Complete information ch

q̄1 = 21 < q1∗ = 25 < q̃1 = 27
Π̄1 = 441 < Π∗1 = 625 < Π̃1 = 729
q̄l = 30 > ql∗ = 28
Π̄l = 900 > Π∗l = 784
qh∗ = 19 > q̃h = 18
Π∗h = 361 > Π̃h = 324

Problem 2: Consider a Cornout duopoly which operates in a market with the following inverse demand
function (
60 − Q if Q ≤ 60,
P (Q) =
0 if Q > 60.
where Q = q1 + q2 is the total output in the market. The cost of firm 2 is c2 (q2 ) = 12q2 with probability
1/4 and c2 (q2 ) = 24q2 with probability 3/4. The cost of firm 1 is c1 (q1 ) = 18q1 . Firm 2 knows its own
cost, but firm 1 only knows the types of costs of firm 2 and its probabilities. The above description is
common knowledge.

1. Represent the above situation as a Bayesian Game. That is, describe the set set of players, their
types, the set of strategies, their beliefs and their utilities.
Solution: There are two players, N = {1, 2}. Their types are T1 = {r}, T2 = {cl , ch } where cl
represents the situation when firm 2 knows that its marginal cost is cl = 12 and ch represents the
situation when firm 2 knows that its marginal cost is ch = 24. The sets of strategies are S1 = [0, ∞)
and S2 = [0, ∞) × [0, ∞) = {(sl , sh ) : sl , sh ∈ [0, ∞)}. Here sl (resp. sh ) represents the strategy of
firm 2 when it knows that its marginal cost is cl = 12 (resp. ch = 24). The beliefs of the players
are
1 3
p1 (cl |r) = ; p1 (ch |r) = , p2 (r|al ) = p2 (r|ah ) = 1
4 4
The utilities of the players are the following.
1 3
u1 (q1 , q2 |r) = (42 − q1 − ql )q1 + (42 − q1 − qh2)q1
4 4
u2 (q1 , ql |cl ) = (48 − q1 − ql )ql
u2 (q1 , qh |ch ) = (36 − q1 − qh )qh

2. Compute the Bayesian Equilibrium and the benefits of the firms in this equilibrium.
Solution: The best response of type cl firm 2 is the solution of the following maximization problem
max ql (48 − q1 − ql )
ql

The solution is
48 − q1
ql = (0.7)
2

3
 The best response of type ch firm 2 is the solution of the following maximization problem

max qh (36 − q1 − qh )
qh

The solution is
36 − q1
qh = (0.8)
2
The best response of firm 1 is the solution of the following maximization problem
1 3
max (42 − q1 − ql ) q1 + (42 − q1 − qh ) q1
q1 4 4
The solution is
168 − ql − 3qh
q1 = (0.9)
8
The Bayesian–Nash equilibrium is the solution to equations (0.7), (0.8) and (0.9). We obtain,
33 21
q1∗ = 15, ql∗ = , qh∗ =
2 2
The benefits are,
1089 441
Π∗1 = 225 Π∗l = Π∗h =
4 4

3. Suppose now that firm 1 knows that the costs of firm 2 is c2 (q2 ) = 12q2 . Compute the Nash
equilibrium and the benefits of the firms in this equilibrium.
Solution: The best response of type cl firm 2 is the solution of the following maximization problem

max q2 (48 − q1 − q2 )
q2

The solution is
48 − q1
q2 = (0.10)
2
The best response of firm 1 is the solution of the following maximization problem

max (42 − q1 − q2 ) q1
q1

The solution is
42 − q2
q1 = (0.11)
2
The Bayesian–Nash equilibrium is the solution to equations (0.10) and (0.11). We obtain,

q̄1 = 12, q̄l = 18

The benefits are,

Π̄1 = 144 Π̄l = 324

4. Suppose now that firm 1 knows that the costs of firm 2 is c2 (q2 ) = 24q2 . Compute the Nash
equilibrium and the benefits of the firms in this equilibrium.
Solution: The best response of type ch firm 2 is the solution of the following maximization problem

max q2 (36 − q1 − q2 )
q2

The solution is
36 − q1
q2 = (0.12)
2

4
 The best response of firm 1 is the same as in (0.10) .The Bayesian–Nash equilibrium is the solution
to equations (0.10) and (0.12). We obtain,
q̃1 = 16, q̃2 = 10
The benefits are,
Π̃1 = 256 Π̃h = 100

5. In view of the above computation there is one type of firm 2 which prefers complete information
and one type that prefers the situation with incomplete information. Identify those types.
Solution: Type cl of firm 2 produces ql = 33 2 and obtains a profit of Πl =
1089
4 with incomplete
information and produces ql = 18 and obtains a profit of Πl = 324 with complete information. It
prefers the situation with complete information. This firm would benefit if it could credibly inform
firm 1 that the the cost of firm 2 is low cl .
Type ch of firm 2 produces qh = 21 441
2 and obtains a profit of Πh = 4 with incomplete information
and produces qh = 10 and obtains a profit of Πh = 100 with complete information. It prefers the
situation with incomplete information. This firm prefers that firm 1 is either not informed or (even
better) that firm 1 believes (wrongly) that the the cost of firm 2 is low cl .
Finally, firm 1 prefers the situation with incomplete information when it faces firm 2 with cost cl .
And it prefers the situation with complete information when it faces firm 2 with cost ch .

Complete information cl Incomplete information Complete information ch

q̄1 = 12 < q1∗ = 15 < q̃1 = 16
Π̄1 = 144 < Π∗1 = 225 < Π̃1 = 256
q̄l = 18 > ql∗ = 33/2
Π̄l = 324 > Π∗l = 1089/4
qh∗ = 21/2 > q̃h = 10
Π∗h = 441/4 > Π̃h = 100

Problem 3: Consider a Cournot duopoly which operates in a market with inverse demand function
P (q) = a − q, where q = q1 + q2 is total output in the market. Firm 2 knows if the value of total demand
a is high (a = ah = 27) or low (a = al = 9). The value of the parameter a is uncertain for firm 1. Firm 1
believes that with probability 2/3 it could be high (a = ah = 27) and with probability 1/3 it could be low
(a = al = 9). All the above is common knowledge and both firms choose simultaneously their production
plans. Both firms have zero cost.

1. Represent this situation as a bayesian game.

Solution: There are two players, N = {1, 2}. Their types are T1 = {r}, T2 = {al , ah } where
al represents the situation when firm 2 knows that a = al = 9 and ah represents the situation
when firm 2 knows that total demand is a = ah = 27. The sets of strategies are S1 = [0, ∞) and
S2 = [0, ∞) × [0, ∞) = {(ql , qh ) : ql , qh ∈ [0, ∞)}. Here ql (resp. qh ) represents the strategy of firm 2
when it knows that the demand is al = 9 (resp. ah = 27). The beliefs are as follows,
1 2
p1 (al |r) = , p1 (ah |r) = , p2 (r|al ) = p2 (r|ah ) = 1
3 3
The utilities of the players are the following

1 2
u1 (q1 , q2 |a) = (9 − q1 − ql )q1 + (27 − q1 − qh )q1
3 3
u2 (q1 , q2 |al ) = (9 − q1 − ql )ql
u2 (q1 , q2 |ah ) = (27 − q1 − qh )qh

5
2. Compute the bayesian equilibrium and the profits in equilibrium.
Solution: The best response of type al firm 2 is the solution of the following maximization problem

max ql (9 − q1 − ql )
ql

The solution is
9 − q1
ql = (0.13)
2
The best response of type ah firm 2 is the solution of the following maximization problem

max qh (27 − q1 − qh )
qh

The solution is
27 − q1
qh = (0.14)
2
The best response of firm 1 is the solution of the following maximization problem
1 2
max (9 − q1 − ql ) q1 + (27 − q1 − qh ) q1
q1 3 3
The solution is
63 − ql − 2qh
q1 = (0.15)
6
The Bayesian–Nash equilibrium is the solution to equations (0.13), (0.14) and (0.15). We obtain,

q1∗ = 7, ql∗ = 1, qh∗ = 10

The benefits are,

Π∗1 = 49 Π∗l = 1 Π∗h = 100

3. Compare the above result with the one in which firm 1 knows the value of a.
Solution: Suppose first that firm 1 knows that the demand is a = al = 9. Then, the best response
of firm 2 is given by (0.13). The best response of firm 1 is the solution of the following maximization
problem
max (9 − q1 − q2 ) q1
q1

The solution is
9 − q2
q1 = (0.16)
2
The Bayesian–Nash equilibrium is the solution to equations (0.13) and (0.16). We obtain,

q̄1 = q̄l = 3

The benefits are,

Π̄1 = Π̄l = 9

Suppose now first that firm 1 knows that the demand is a = ah = 27. Then, the best response of
firm 2 is given by (0.14). The best response of firm 1 is the solution of the following maximization
problem
max (27 − q1 − q2 ) q1
q1

The solution is
27 − q2
q1 = (0.17)
2
The Bayesian–Nash equilibrium is the solution to equations (0.13) and (0.17). We obtain,

q̃1 = q̃h = 9

The benefits are,

Π̃1 = Π̃h = 81

6
 Complete information cl Incomplete information Complete information ch
q̄1 = 3 < q1∗ = 7 < q̃1 = 9
Π̄1 = 9 < Π∗1 = 49 < Π̃1 = 81
q̄l = 30 > ql∗ = 3
Π̄l = 900 > Π∗l = 9
qh∗ = 10 > q̃h = 9
Π∗h = 100 > Π̃h = 81

Problem 4: (The battle of the sexes) A couple is deciding wether to go to the soccer match or to the
ballet. Each of the partners has to make the decision simultaneously and independently (they cannot
communicate). She (player 1) likes soccer very much, but would prefer to go with her partner. He
(player 2) enjoys ballet way more than soccer. Sometimes he prefers to go with his partner, but some
other times he prefers to go alone (you can imagine the reasons). He knows his mood tonight. But, she
does not. She thinks that the probability that he would enjoy her company tonight is 1/2. The situation
is summarized in the following tables.

He He
S B S B
She S 4,2 0,0 She S 4,0 0,4
B 0, 0 2,4 B 0, 2 2,0
He prefers her company He prefers to be alone

(a) Describe the situation as a Bayesian game.

Solution: There are two players, N = {1, 2}. Their types are T1 = {c}, T2 = {a, b} where a
represents the situation when agent 2 knows that the payoffs are those in table A and b represents the
situation when when agent 2 knows that the payoffs are those in table B. The sets of strategies are
S1 = {S, B}, S2 = {SS, SB, BS, BB}. The beliefs of the players are
1
p1 (a|c) = p1 (b|c) = , p2 (c|a) = p2 (c|b) = 1
2
The utilities of the players are given by the above tables. For example u1 (B, B|c, a) = 2, u2 (S, B|c, b) =
4.
(b) Find the Bayesian equililibria.
Solution: Note that BR2 (S) = SB, BR2 (B) = BS. And
1 1 1 1
u1 (S, SB) = ×4+ × 0 = 2, u1 (B, SB) = ×0+ ×2=1
2 2 2 2
1 1 1 1
u1 (S, BS) = ×0+ × 4 = 2, u1 (B, BS) = × 2 + ×0=1
2 2 2 2

Hence, BR1 (SB) = S, BR1 (BS) = S. Therefore, The NE in pure strategies is (S, SB).
We compute now the BNE in mixed strategies. Suppose player 1 uses the mixed strategy xS +(1−x)B,
player 2a uses the mixed strategy yS + (1 − y)B and player 2b uses the mixed strategy zS + (1 − z)B.
Note that

P2 P2
y 1−y z 1−z
S B S B
P1 x S 4,2 0,0 P1 x S 4,0 0,4
1-x B 0, 0 2,4 1-x B 0, 2 2,0
a b

7
 u2 (xS + (1 − x)B, S|a) = 2x, u2 (xS + (1 − x)B, B|a) = 4(1 − x)
Hence, player 2a is indifferent between the strategies S and B if and only if 2x = 4(1 − x), that is if
and only if x = 32 . Now given this values of x,
2
u2 (xS + (1 − x)B, S|b)|x= 2 = 2(1 − x)|x= 2 =
3 3 3
8
u2 (xS + (1 − x)B, B|b)|x= 2 = 4x|x= 2 =
3 3 3
Hence,
2 1
BR2 ( S + B|a) = {B, S}
3 3
2 1
BR2 ( S + B|b) = B
3 3
In other words,
2 1
BR2 ( S + B) = {BB, SB}
3 3
That is, if player 1 follows the strategy 23 S + 13 B player 2a is indifferent between S and B and player 2b
best response is B. Thus, we look for a BNE of the form
 
2 1
S + B, (yS + (1 − y)B, B)
3 3
If player 2 follows that above strategy, the expected payoffs of player 1 are
1 1
u1 (S, (yS + (1 − y)B, B)) = (4y + 0(1 − y)) + × 0 = 2y
2 2
1 1
u1 (B, (yS + (1 − y)B, B)) = (0y + 2(1 − y)) + ×2=2−y
2 2
Hence, player 1 is indifferent between strategies S and B if and only if 2y = 2 − y, that is if and only
if y = 32 . It is now easy to check that the strategy
  
2 1 2 1
S + B, S + B, B
3 3 3 3
is BNE. The (expected) payoffs of the players are
  
2 1 2 1 4
u1 S + B, S+ B, B =
3 3 3 3 3
  
2 1 2 1
u2 S + B, S+ B, B = 2
3 3 3 3
We look now for another BNE in which player 2b uses mixed strategies. Note that

u2 (xS + (1 − x)B, S|b) = 2(1 − x), u2 (xS + (1 − x)B, B|b) = 4x

Hence, player 2b is indifferent between the strategies S and B if and only if 2(1 − x) = 4x, that is if
and only if x = 31 . Now given this values of x,
2
u2 (xS + (1 − x)B, S|a)|x= 1 = 2x|x= 1 =
3 3 3
8
u2 (xS + (1 − x)B, B|a)|x= 1 = 4(1 − x)|x= 1 =
3 3 3
Hence,
1 1
BR2 ( S + B|a) = B
3 3
1 2
BR2 ( S + B|b) = {B, S}
3 3

8
In other words,
1 1
BR2 ( S + ) = {BB, BS}
3 3
1 2
That is, if player 1 follows the strategy 3 S + 3 B player 2b is indifferent between S and B and player 2a
b’s best response is B. Thus, we look for a BNE of the form
 
1 2
S + B, (B, zS + (1 − z)B)
3 3
If player 2 follows that above strategy, the expected payoffs of player 1 are
1 1
u1 (S, (B, zS + (1 − z)B)) = (4y + 0(1 − y)) + × 0 = 2z
2 2
1 1
u1 (B, (B, zS + (1 − z)B)) = (0y + 2(1 − y)) + ×2=2−z
2 2
Hence, player 1 is indifferent between strategies S and B if and only if 2z = 2 − z, that is if and only
if z = 32 . It is now easy to check that the strategy
  
1 2 2 1
S + B, B, S + B
3 3 3 3
is BNE. The (expected) payoffs of the players are
  
1 2 2 1 4
u1 S + B, B, S + B =
3 3 3 3 3
  
1 2 2 1
u2 S + B, B, S + B = 2
3 3 3 3

Solution 2: Another way to find this is to note that,

1 1 1 1
u1 (S, SS) = ×4+ × 4 = 4, u1 (B, SS) = ×0+ ×0=0
2 2 2 2
1 1 1 1
u1 (S, SB) = ×4+ × 0 = 2, u1 (B, SB) = × 0 + × 2 = 1
2 2 2 2
1 1 1 1
u1 (S, BS) = ×0+ × 4 = 2, u1 (B, BS) = × 2 + × 0 = 1
2 2 2 2
1 1 1 1
u1 (S, BB) = ×0+ × 0 = 0, u1 (B, BB) = × 2 + × 2 = 2
2 2 2 2

and
1 1 1 1
u2 (S, SS) = ×2+ × 0 = 1, u2 (B, SS) = ×0+ ×2=1
2 2 2 2
1 1 1 1
u2 (S, SB) = ×2+ × 4 = 3, u2 (B, SB) = × 0 + × 0 = 0
2 2 2 2
1 1 1 1
u2 (S, BS) = ×0+ × 0 = 0, u2 (B, BS) = × 4 + × 2 = 3
2 2 2 2
1 1 1 1
u2 (S, BB) = ×0+ × 4 = 2, u2 (B, BB) = × 4 + × 0 = 2
2 2 2 2

Now, we construct the table

P2
SS SB BS BB
P1 S 4,1 2,3 2,0 0,2
B 0,1 1,0 1,3 2,2
Expected payoffs

9
Hence, the BNE in pure strategies is (S, SB).
We find now the BNE in mixed strategies. Suppose again that player 1 uses the mixed strategy
xS + (1 − x)B, player 2a uses the mixed strategy yS + (1 − y)B and player 2b uses the mixed strategy
zS + (1 − z)B. Then

p(SS) = yz, p(SB) = y(1 − z), p(BS)(1 − y)z, p(BB) = (1 − y)(1 − z)

So, we get the table

P2
yz y(1 − z) (1 − y)z (1 − y)(1 − z)
SS SB BS BB
P1 x S 4,1 2,3 2,0 0,2 2 (y + z)
1-x B 0,1 1,0 1,3 2,2 2-y-z
1 3x 3(1-x) 2
Expected payoffs

Graphically,

u2

u2 = 3(1 − x) u2 = 3x

u2 = 2

u2 = 1

1 2
1 x
3 3

We see that 
BS

 if 0 ≤ x < 13
{BS, BB} if x = 13



1 2
BR2 (x) = BB if 3 <x< 3
x = 23

{SB, BB} if




x > 23

SB if

For 0 < x < 31 , the best reply of player 2 is BS and BR1 (BS) = S. But, BR2 (S) = SB. Hence,
there is no BNE with 0 < x < 13 .
For x = 13 , the best reply of player 2, type a is B and player 2, type b is indifferent between S and
B. Thus, we must have y = 0. Player 1 follows a mixed strategy only if 2y + 2z = 2 − y − z. Since,
y = 0 this is equivalent to 2z = 2 − z, that is z = 23 . We obtain the BNE
  
1 2 2 1
S + B, B, S + B .
3 3 3 3

10
 1
For 3 < x < 23 , the best reply of player 2 is BB. Since,
1 1 1 1
u1 (S, BB) = × 0 + × 0 = 0, u1 (B, BB) = ×2+ ×2=2
2 2 2 2

1
we have that BR1 (BB) = B. But, BR2 (B) = BS. Hence, there is no BNE with 3 < x < 23 .
For x = 23 , the best reply of player 2, type b is B and player 2, type a is indifferent between S and
B. Thus, we must have z = 0. Player 1 follows a mixed strategy only if 2y + 2z = 2 − y − z. Since,
y = 0 this is equivalent to 2y = 2 − y, that is y = 32 . We obtain the BNE
  
2 1 2 1
S + B, S + B, B
3 3 3 3

Finally, for 32 < x ≤ 1, the best reply of player 2 is SB. We have that BR1 (SB) = S, that is x = 1.
Also, BR2 (S) = SB and we recover the BNE (S, SB).

Problem 5: Consider the situation in which player 2 knows what game is played (A or B below). But
player 1 only knows that A is played with probability p and B is played with probability 1 − p.

Player 2 Player 2
S B S B
Player 1 S 2,2 1,0 Player 1 S 2,2 0,5
B 1, 5 0,2 B 0, 0 4,2
A B

(a) Describe the situation as a Bayesian game.

Solution: There are two players, N = {1, 2}. Their types are T1 = {c}, T2 = {a, b} where a
represents the situation when agent 2 knows that the payoffs are those in table A and b represents the
situation when when agent 2 knows that the payoffs are those in table B. The sets of strategies are
S1 = {S, B}, S2 = {SS, SB, BS, BB}. The beliefs of the players are
p1 (a|c) = p, p (b|c) = 1 − p, p2 (c|a) = p2 (c|b) = 1
The utilities of the players are given by the above tables. For example u1 (B, B|c, a) = 0, u2 (S, B|c, b) =
5.
(b) Find the Bayesian equililibria.
Solution: Note that strategy B is dominated by strategy S for player 2a and strategy S is dominated
by strategy B for player 2b. Hence, the BNE are of the form
(xS + (1 − x)B, SB) , x ∈ [0, 1]
We remark now that
u1 (S, SB) = 2p, u1 (B, SB) = 4 − 3p
4
Since 2p ≥ 4 − 3p if and only if p ≥ we have that
5

4
S,
 if p > 5
4
BR1 (SB) = {S, B}, if p = 5
4

B, if p <

5

Therefore the NE are

4
(S, SB), if p > 5
4
(xS + (1 − x)B, SB) with x ∈ [0, 1], if p = 5
4
(B, SB), if p < 5

11
Problem 6: Consider the situation in which player 1 knows what game is played (A or B below). But
player 2 only knows that A is played with probability 1/3 and B is played with probability 2/3.

Player 2 Player 2
S B S B
Player 1 S 1,1 0,0 Player 1 S 0,0 0,0
B 0, 0 0,0 B 0, 0 2,2
A B

(a) Describe the situation as a Bayesian game.

Solution: There are two players, N = {1, 2}. Their types are T1 = {a, b}, T2 = {c} where a
represents the situation when agent 1 knows that the payoffs are those in table A and b represents the
situation when when agent 1 knows that the payoffs are those in table B. The sets of strategies are
S1 = {SS, SB, BS, BB}, S2 = {S, B}. The beliefs of the players are
1 2
p1 (c|a) = p1 (c|b) = 1, p2 (a|c) = , p (b|c) =
3 3
The utilities of the players are given by the above tables.
(b) Find the Bayesian equililibria.
Solution: Note that,
1 2 1 1 2
u1 (SS, S) = ×1+ ×0= , u1 (SS, B) =×0+ ×0=0
3 3 3 3 3
1 2 1 1 2 4
u1 (SB, S) = ×1+ ×0= , u1 (SB, B) = × 0 + × 2 =
3 3 3 3 3 3
1 2 1 2
u1 (BS, S) = ×0+ × 0 = 0, u1 (BS, B) = × 0 + × 0 = 0
3 3 3 3
1 2 1 2 4
u1 (BB, S) = ×0+ × 0 = 0, u1 (BB, B) = × 0 + × 2 =
3 3 3 3 3

and
1 2 1 1 2
u2 (SS, S) = ×1+ ×0= , u2 (SS, B) =×0+ ×0=0
3 3 3 3 3
1 2 1 1 2 4
u2 (SB, S) = ×1+ ×0= , u2 (SB, B) = × 0 + × 2 =
3 3 3 3 3 3
1 2 1 2
u2 (BS, S) = ×0+ × 0 = 0, u2 (BS, B) = × 0 + × 0 = 0
3 3 3 3
1 2 1 2 4
u2 (BB, S) = ×0+ × 0 = 0, u2 (BB, B) = × 0 + × 2 =
3 3 3 3 3

Now, we construct the table

P2
S B
1 1
SS 3,3 0,0
1 1 4 4
SB 3,3 3,3
P1
BS 0,0 0,0
4 4
BB 0,0 3,3

Expected payoffs
An we look for a NE of the form
σ1 = xSS + ySB + zBS + (1 − x − y − z)BB
σ2 = qS + (1 − q)B
We get the table

12
 P2
q 1 -q
S B
1 1 q
x SS 3,3 0,0 3
1 1 4 4 4
y SB 3,3 3,3 3 −q
P1
z BS 0,0 0,0 0
1-x-y-z BB 0,0 4 4
3,3
4
3 − 4q
3
x+y 4
3 3 (1 − x − z)
Expected payoffs

Graphically,

u2

4
u1 (SB, σ2 ) = 3 −q
4 4q
u1 (BB, σ2 ) = 3 − 3 q
u1 (SS, σ2 ) = 3

4
1 q
5

We see that 
{SB, BB}
 if q = 0
BR1 (q) = {SB} if 0 < q < 1

{SS, SB} if q = 1


We may assume z = 0. We obtain, the table

P2
q 1 -q
S B
1 1 q
x SS 3,3 0,0 3
1 1 4 4 4
3 −q
P1 y SB 3,3 3,3
4 4 4 4q
1-x-y BB 0,0 3,3 3 − 3
x+y 4
3 3 (1 − x)
Expected payoffs

• Is there a BNE with q = 0? In this equilibrium we must have that x = 0. We obtain, the table
P2
q=0 1−q =1
S B
1 1 4 4 4
y SB 3,3 3,3 3
P1 4 4 4
1-y BB 0,0 3,3 3
y 4
3 3

Expected payoffs

13
 We obtain the BNE
(ySB + (1 − y)BB, B) 0≤y≤1
with payoffs u1 = u2 = 34 .
• Is there a BNE with 0 < q < 1? In this equilibrium we must have that y = 1. But, then
BR2 (SB) = B. That is, player 2 best reply to SB is to choose q = 0. Hence, there is no BNE
with 0 < q < 1.
• Is there a BNE with q = 1? In this equilibrium we must have that x + y = 1. We obtain, the
table
P2
q=1 1−q =0
S B
1 1 1
x SS 3,3 0,0 3
P1 1 1 4 4 1
1-x SB 3,3 3,3 3
1 4
3 3 (1 − x)
Expected payoffs
We need that
1 4
≥ (1 − x)
3 3
that is x ≥ 43 . We obtain the following BNE

3
(xSS + (1 − x)SB, S) ≤x≤1
4
with payoffs u1 = u2 = 31 .

Problem 7: Two individuals consider donating towards a public good. If any of the agents contributes
to the public good, then it is implemented. If agent agent i = 1, 2 contributes to the public good his
utility is ui = 2 − ci . If agent i = 1, 2 does not contribute to the public good, but agent j 6= i contributes
to the public, the utility of agent i is ui = 2. It is known that c1 = 1. Only agent 2 knows c2 . Agent 1
knows that c2 = 1 with probability p and c2 = 3 with probability 1 − p. That is player 2 knows what
game is played (A or B below). But player 1 only knows that A is played with probability p and B is
played with probability 1 − p.

Player 2 Player 2
C N C N
Player 1 C 1,1 1,2 Player 1 C 1,-1 1,2
N 2, 1 0,0 N 2, −1 0,0
A B

(a) Describe the situation as a Bayesian game.

Solution: There are two players, N = {1, 2}. Their types are T1 = {c}, T2 = {a, b} where a
represents the situation when agent 2 knows that the payoffs are those in table A and b represents the
situation when when agent 2 knows that the payoffs are those in table B. The sets of strategies are
S1 = {C, N }, S2 = {CC, CN, N C, N N }. The beliefs of the players are

p1 (a|c) = p, p (b|c) = 1 − p, p2 (c|a) = p2 (c|b) = 1

The utilities of the players are given by the above tables. For example u1 (C, N |c, a) = 1, u2 (N, C|c, b) =
−1.

14
(b) Find the Bayesian equililibria.
Solution: Note that strategy C is dominated by strategy N for player 2b. Hence, the BNE are of the
form (∗, ∗N ). We remark that BR2 (C|a) = N , BR2 (N |a) = C. So, BR2 (C) = N N , BR2 (N ) = CN .
On the other hand,
u1 (C, N N ) = 1, u1 (N, N N ) = 0
So, BR1 (N N ) = C. Hence, (C, N N ) is a BNE, for any 0 ≤ p ≤ 1. Note also that

u1 (C, CN ) = 1, u1 (N, (CN ) = 2p


C
 if p < 1/2
BR1 (CN ) = {C, N } if p = 1/2

N if p > 1/2


and we see that if p ≥ 1/2, then (N, CN ) is a BNE with payoffs u1 = 1, u2 = 2. We look now for
a mixed strategy BNE. Suppose player 1 uses the mixed strategy σ1 = xC + (1 − x)N and player 2a
uses the mixed strategy σ2 = yC + (1 − y)N . Then, the expected payoffs are,

u1 (C, σ2 ) = 1
u1 (N, σ2 ) = 2yp

and

u2 (σ1 , CN |a) = 1
u2 (σ1 , N N |a) = 2x

So, x = 21 . Hence, for p ≥ 12 , there is a mixed strategy BNE

  
1 1 1 2p − 1
C + N, C+ N, N
2 2 2p 2p
with payoffs u1 = u2 = 1.

Problem 8: Two individuals consider donating towards a public good. If any of the agents contributes
to the public good, then it is implemented. If agent agent i = 1, 2 contributes to the public good his
utility is ui = 2 − ci . If agent i = 1, 2 does not contribute to the public good, but agent j 6= i contributes
to the public, the utility of agent i is ui = 2. That is

Player 2
C N
Player 1 C 2 − c1 , 2 − c2 2 − c1 ,2
N 2, 2 − c2 0,0

where c1 and c2 are distributed uniformly on the interval [1, 3].

(a) Describe the situation as a Bayesian game.

Solution: There are two players, N = {1, 2}. Their types are T1 = T2 = [1, 3]. The sets of strategies
are S1 = S2 = {C, N }. The beliefs of the players are

0
 if c < 1
c−1
p1 (c2 ≤ c|c1 ) = p2 (c1 ≤ c|c2 ) = 2 if c ∈ [1, 3] ,

1 if c > 3


The utilities of the players are given by the above tables.

15
(b) Show that there is a Bayesian equilibrium of the form (s1 (c1 ), s2 (c2 )) with
(
C if ci ≤ a
si (ci ) = , i = 1, 2
N if ci > a

for some a ∈ [1, 3]: Solution: The expected utility of agent 1 with the proposed strategy is

u1 (C, s2 (c2 )) = (2 − c1 )p (c2 ≤ a) + (2 − c1 )p (c2 > a) = 2 − c1

2(a − 1)
u1 (N, s2 (c2 )) = 2p (c2 ≤ a) + 0 × p (c2 > a) = =a−1
2

Let ε ≥ 0 and let c1 = a − ε. For agent 1, strategy C is a best reply iff 2 − c1 ≥ a − 1, that is iff
2 − a + ε ≥ a − 1. Hence, we need that
3 ε
a≤ + for any ε ≥ 0
2 2
Now let c1 = a + ε. For agent 1 strategy D is a best reply iff 2 − c1 ≤ a − 1, that is iff 2 − a − ε ≤ a − 1.
Hence, we need that
3 ε
− ≤ a for any ε ≥ 0
2 2
We see that if a = 23 , then the strategy
(
3
C if ci ≤ 2
s1 (c1 ) = 3
,
N if ci > 2

is a best reply to s2 (c2 ). A similar argument shows that s2 (c2 ) is a best reply for agent 2 to s1 (c1 ).
The payoffs in this equilibrium are
(
2 − ci if ci ≤ 23
ui (s1 (c1 ), s2 (c2 ); ci ) = 1 , i = 1, 2
2 if ci > 32

Problem 9:
√
Two risk averse individuals with utility functions u(x) = x, where x represents money, face a first
price auction. Agent i = 1, 2 (i = 1, 2) values the good in vi monetary units. This valuation is private
information, but it is known that the vi ’s are random variables independently and uniformly distributed
in the interval [0, 1].

(a) Describe the situation as a Bayesian game.

Solution: There are two players, N = {1, 2}. Their types are T1 = T2 = [0, 1]. The sets of strategies
are Si (vi ) = [0, vi ] i = 1, 2. The beliefs of the players are

o
 if c < 0
p1 (v2 ≤ c|v1 ) = p2 (v1 ≤ c|v2 ) = c if c ∈ [0, 1] ,

1 if c > 1


The utilities of the players are


0√
 if bi < bj
vi −bi
ui (b1 , b2 ; vi ) = if bi = bj i = 1, 2, i 6= j
√ 2
v i − bi if bi > bj


16
(b) Find a bayesian Nash equilibrium of the form bi (vi ) = αi vi . What is the utility of each individual in
equilibrium?
Solution: Suppose player 2 follows the strategy b2 (v2 ) = α2 v2 . If player 1 chooses to bid b1 , his
expected utility is
p 1p
u1 (b1 |v1 ) = p(b1 > b2 (v2 )) v1 − b1 + p(b1 = b2 (v2 )) v1 − b1 + 0 × p(b1 (v1 ) < b2 (v2 ))
p 2
= v1 − b1 p(b1 > b2 (v2 ))

because p(b1 = b2 (v2 )) = 0. Thus,

  √
p p b1 p b1 v 1 − b1
u1 (b1 |v1 ) = p(b1 > b2 (v2 )) v1 − b1 = p(b1 > α2 v2 ) v1 − b1 = p v2 < v 1 − b1 =
α2 α2

The best reply of player 1 is given my the solution to

p
max b1 v1 − b1
b1

The first order condition is

p b1
v 1 − b1 = √
2 v1 − b1
whose solution is
2
b1 (v1 ) = v1
3
Similarly, if player 1 follows the strategy b1 (v1 ) = α1 v1 the best reply for player 2 is
2
b2 (v2 ) = v2
3
Hence
2
bi (vi ) = vi , i = 1, 2
3
is BNE. The expected payoff of agent i = 1, 2 is
q
2
3 vi vi − 23 vi
r
2 32
ui (b1 (v1 ), b2 (v2 ); vi ) = = v
2
3
3 i

17