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Problem
Problem 1: Let (N, {St}i€ N {u;} ;EN) be a normal form game. Suppose for each i, the
set of actions Si is a compact set, and each ui is continuous. Let S? = Si, and define

Problem 3 (Cournot Competition with Different Costs): Suppose each of two firms
produces a homogeneous good and the two firms simultaneously choose quatities
q1, q2 ∈ (0, ∞) to produce. Inverse demand given total quantity Q = q1 + q2 is P(Q)
= a Q for some a > 0. Both firms have constant marginal costs of production, but
firm 1 has a higher cost: c1 > c2.

(a) Find the Nash equilibrium of this game.

(b) Which firm produces more output in equilibrium?
(c) How do the outputs of the two firms change if we lower c2?

Problem 4 (Bertrand Competition with Discrete Pricing): Suppose each of two firms
produces a homogeneous good at constant marginal cost 1 2 . The two firms
simultaneously set integer valued prices (that is, pi ∈ {0, 1, 2, 3, ...} for each firm i ∈
{1, 2}). Total demand is 1 at any price less than 4, and total demand is zero if the
price is 4 or higher.
(a) Suppose the two firms split demand evenly if they choose the same price;
otherwise the full demand goes to the lower priced firm. Charactcerize the set
of pure-strategy Nash equilibria.

(b) Suppose firm 1 is the “incumbent,” and will retain all demand unless firm 2
undercuts firm 1’s price. That is, if the two firms charge the same price, firm 1
receives the full demand. Characterize the set of pure-strategy Nash equilibria.

(c) Does firm 1 benefit from its status as the “incumbent?”

Problem 5 (A Graphical Coordination Game): Let N denote a finite set of players.

The players are linked in an undirected graph G in which some edges are colored
red and other edges are colored blue. For player i, let Ni,r denote the set of players
linked to i along red edges, and let Ni,b denote the set of players linked to i along
blue edges. Players simultaneously choose one of two actions, A or B, so Si = {A,
B} for each i. Player i’s payoff is

That is, player i earns a unit of utility for each red neighbor she matches and loses
a unit of utility for each blue neighbor she matches. Show that this is an (exact)
potential game.

Problem 6: Consider the traffic flow game pictured in the figure below. There are
two origindestination pairs. A unit of traffic needs to flow from the upper left to
the upper right, and another unit needs to flow from the lower left to the lower
right. The cost functions are given in the figure.

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(a) What is the socially optimal routing, and what is its total cost?

(b) What is the equilibrium routing? What is the welfare loss relative to the optimum?

(c) Suppose you can impose constant tolls on some edges and constant subsidies on
others. Design a system of tolls and subsidies to implement the social optimum as
an equilibrium.

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Solution

Problem 3

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Problem 4

(a) Firm i earns profit (pi 1/2)qi where pi is its own action and qi is 4 if pi < pj
∧ 4, 2 if pi = pj < 4, and 0 otherwise. Thus, the normal form game is given by

The pure-strategy Nash equilibria are (p1, p2) = (1, 1) and (2, 2).

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(b) Now, the normal form game is given by

Therefore, the only pure-strategy Nash equilibrium is (p1, p2) = (1, 1).

(c) Compared to (1, 1) in (a), firm 1 benefits for payoff 1 by its incumbency;
however, relative to (2, 2) in (a), firm 1 loses payoff of 1.

Problem 5

Define Φ : S → R by

Problem 6

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