In Class Exercises Problem 1 A group of n students go to a ...

Topics in Microeconomics 2009-10 Kirori Mal College, University of Delhi 

In Class Exercises 

Problem 1 

A group of n students go to a restaurant. Each person will simultaneously choose his own meal 

but the total bill will be shared amongst all the students. If a student chooses a meal of price p 

and contributes x towards paying the bill, then his payoff is √p − x. Compute all pure strategy 

Nash equilibria of this game. Is the equilibrium unique? Symmetric? Discuss the limiting cases 

of n = 1 and n → ∞. 


Each of n ≥ 2, i = 1, ..., n can make contributions si ∈ [0, w] (w > 0) to the production of some 

public good. Their payoff functions are given by πi (s1, .., sn) = n(min{s1, .., sn}) − si. Find all 

pure strategy Nash equilibria in the game. 


Consider an n firm quantity setting game where the cost function for firm i is given by Ci(xi) = 

ci.xi where ci ≥ 0. The inverse demand function is given P(X) = a − bX where a, b > 0 and X = x1 

+ ... + xn. The payoff function for firm i is therefore πi (x1, .., xn) = (a − b(∑j xj)xi − ci.xi. 

(i) Compute a (pure strategy) Nash equilibrium for the game. Compute also the equilibrium 

price. 

(ii) What happens to the equilibrium quantity choice of firm j if there is an increase in firm i’s 

cost; i.e in ci? What happens to equilibrium price? 


Players 1 and 2 are bargaining over how to split one rupee. Both players simultaneously name 

shares they would like to have, s1 and s2, where 0 ≤ s1, s2 ≤ 1. If s1 + s2 ≤ 1, then the players 

receive the shares they named; if s1 + s2 > 1, then both players receive zero. What are the purestrategy 

Nash equilibria of the game?


a. Write down the set of players, set of terminal histories, player function, and players’ 

preferences for the game above 

b. Represent the above game in normal form and suggest the Nash Equilibria. 

c. How many subgames does the game above has? Find all Nash Equilibrium of each 

subgame of the game above. 

d. Now, Find subgame perfect Nash Equilibrium. What is the outcome if SPNE is played? 

EXERCISE 154.2 (Examples of extensive games with perfect information) 

a. Represent in a diagram the two-player extensive game with perfect information in which 

the terminal histories are (C, E), (C, F), (D, G), and (D, H), the player function is given 

by P(∅) = 1 and P(C) = P(D) = 2, player 1 prefers (C, F) to (D, G) to (C, E) to (D, H), 

and player 2 prefers (D, G) to (C, F) to (D, H) to (C, E). 

b. The political figures Rosa and Ernesto each has to take a position on an issue. The 

options are Berlin (B) or Havana (H). They choose sequentially. A third person, Karl, 

determines who chooses first. Both Rosa and Ernesto care only about the actions they 

choose, not about who chooses first. Rosa prefers the outcome in which both she and 

Ernesto choose B to that in which they both choose H, and prefers this outcome to either 

of the ones in which she and Ernesto choose different actions; she is indifferent between 

these last two outcomes. Ernesto’s preferences differ from Rosa’s in that the roles of B 

and H are reversed. Karl’s preferences are the same as Ernesto’s. Model this situation as 

an extensive game with perfect information. (Specify the components of the game and 

represent the game in a diagram.) 

c. Write down the set of players, set of terminal histories, player function, and players’ 

preferences for the game in Figure below: 

d. Represent the above games in normal forms carefully listing the strategies and the payoffs, solve 

for Nash Equilibrium and Sub-game perfect Nash Equilibrium. 

EXERCISE 161.2 (Voting by alternating veto) Two people select a policy that affects them both 

by alternately vetoing policies until only one remains. First person 1 vetoes a policy. If more 

than one policy remains, person 2 then vetoes a policy. If more than one policy still remains,


person 1 then vetoes another policy. The process continues until only one policy has not been 

vetoed. Suppose there are three possible policies, X, Y, and Z, person 1 prefers X to Y to Z, and 

person 2 prefers Z to Y to X. Model this situation as an extensive game and find its Nash 

equilibria. 

EXERCISE 171.4 (Burning a bridge) Army 1, of country 1, must decide whether to attack army 

2, of country 2, which is occupying an island between the two countries. In the event of an attack, 

army 2 may fight, or retreat over a bridge to its mainland. Each army prefers to occupy the 

island than not to occupy it; a fight is the worst outcome for both armies. Model this situation as 

an extensive game with perfect information and show that army 2 can increase its subgame 

perfect equilibrium payoff (and reduce army 1’s payoff) by burning the bridge to its mainland, 

eliminating its option to retreat if attacked.


EXERCISE 183.2 (Dividing a cake fairly) Two players use the following procedure to divide a 

cake. Player 1 divides the cake into two pieces, and then player 2 chooses one of the pieces; 

player 1 obtains the remaining piece. The cake is continuously divisible (no lumps!), and each 

player likes all parts of it. 

a. Suppose that the cake is perfectly homogeneous, so that each player cares only about the size 

of the piece of cake she obtains. How is the cake divided in a subgame perfect equilibrium? 

b. Suppose that the cake is not homogeneous: the players evaluate different parts of it differently. 

Represent the cake by the set C, so that a piece of the cake is a subset P of C. Assume that if P is 

a subset of P’ not equal to P’ (smaller than P’) then each player prefers P’ to P. Assume also 

that the players’ preferences are continuous: if player i prefers P to P’ then there is a subset of P 

not equal to P that player i also prefers to P’. Let (P1, P2) (where P1 and P2 together constitute 

the whole cake C) be the division chosen by player 1 in a subgame perfect equilibrium of the 

divide-and-choose game, P2 being the piece chosen by player 2. Show that player 2 is indifferent 

between P1 and P2, and player 1 likes P1 at least as much as P2. Give an example in which player 

1 prefers P1 to P2. 

EXERCISE 188.1 (Stackelberg’s duopoly game with fixed costs) Suppose that the inverse 

demand function is given by 

and the cost function of each firm i is 

where c ≥ 0, f > 0, and c < α. Show that if c = 0, α = 12, and f = 4, Stackelberg’s game has a 

unique subgame perfect equilibrium, in which firm 1’s output is 8 and firm 2’s output is zero. 

A legislature has k members, where k is an odd number. Two rival bills, X and Y, are being 

considered. The bill that attracts the votes of a majority of legislators will pass. Interest group X 

favors bill X, whereas interest group Y favors bill Y. Each group wishes to entice a majority of 

legislators to vote for its favorite bill. First interest group X gives an amount of money (possibly 

zero) to each legislator, then interest group Y does so. Each interest group wishes to spend as 

little as possible. Group X values the passing of bill X at $VX > 0 and the passing of bill Y at 

zero, and group Y values the passing of bill Y at $VY > 0 and the passing of bill X at zero. (For 

example, group X is indifferent between an outcome in which it spends VX and bill X is passed 

and one in which it spends nothing and bill Y is passed.) Each legislator votes for the favored 

bill of the interest group that offers her the most money; a legislator to whom both groups offer 

the same amount of money votes for bill Y (an arbitrary assumption that simplifies the analysis 

without qualitatively changing the outcome). For example, if k = 3, the amounts offered to the 

legislators by group X are x = (100, 50, 0), and the amounts offered by group Y are y = (100, 0, 

50), then legislators 1 and 3 vote for Y and legislator 2 votes for X, so that Y passes. (In some 

legislatures the inducements offered to legislators are more subtle than cash transfers.)


We can model this situation as the following extensive game. 

Players The two interest groups, X and Y. 

Terminal histories The set of all sequences (x, y), where x is a list of payments to legislators 

made by interest group X and y is a list of payments to legislators made by interest group Y. 

(That is, both x and y are lists of k nonnegative integers.) 

Player function P(∅) = X and P(x) = Y for all x. 

Preferences The preferences of interest group X are represented by the payoff function 

where bill Y passes after the terminal history (x, y) if and only if the number of components of y 

that are at least equal to the corresponding components of x is at least 0.5 (k + 1) (a bare 

majority of the k legislators). The preferences of interest group Y are represented by the 

analogous function (where VY replaces VX, y replaces x, and Y replaces X). 

EXERCISE 193.1 (Three interest groups buying votes) Consider a variant of the model in which 

there are three bills, X, Y, and Z, and three interest groups, X, Y, and Z, who choose lists of 

payments sequentially. Ties are broken in favor of the group moving later. Find the bill that is 

passed in any subgame perfect equilibrium when k = 3 and (a) VX = VY = VZ = 300, (b) VX = 

300, VY = VZ = 100, and (c) VX = 300, VY = 202, VZ = 100. 

EXERCISE 193.4 (Sequential positioning by three political candidates) Consider a further 

variant of Hotelling’s model of electoral competition in which the n candidates choose their 

positions sequentially and each candidate has the option of staying out of the race. Assume that 

each candidate prefers to stay out than to enter and lose, prefers to enter and tie with any 

number of candidates than to stay out, and prefers to tie with as few other candidates as 

possible. Model the situation as an extensive game and find the subgame perfect equilibrium 

outcomes when n = 2 (easy) and when n = 3 and the voters’ favorite positions are distributed 

uniformly from 0 to 1 (i.e. the fraction of the voters’ favorite positions less than x is x) (hard).


1. Consider the first-price sealed-bid auction, but each bidder i observes only his own valuation 

vi. The valuation is distributed uniformly and independently on [0, v*] for each bidder. 

Derive symmetric (pure strategy) Bayesian Nash equilibrium of this auction if there are two 

bidders. Suppose that bids can only be non-negative. (Look for an equilibrium in which 

bidder i’s bid is a linear function of his valuation.) 

2. Consider the following strategic situation. Two opposed armies are poised to seize an island. 

Each army’s general can choose either “attack” or “not attack.” In addition, each army is 

either “strong” or “weak” with equal probability (the draws for each army are independent), 

and an army’s type is known only to its general. Payoffs are as follows: The island is worth 

M if captured. An army can capture the island either by attacking when its opponent does not 

or by attacking when its rival does if it is strong and its rival is weak. If two armies of equal 

strength both attack, neither captures the island. An army also has a “cost” of fighting, 

which is s if it is strong and w if it is weak, where s


simultaneous and independent choices and receive payoffs as described by the following 

matrix. 

1↓2 → X Y 

A 0, 1 1, 0 

B 1, 0 c, 1 

Compute the Bayesian Nash equilibrium. 

6. Consider the following game. Nature selects A with probability ½ and B with probability ½. 

If nature selects A, then players 1 and 2 interact according to matrix “A”. If nature selects B, 

then the players interact according to matrix “B”. Suppose that, before the players select 

their actions, player 1 observes nature’s choice. (That is, player 1 knows which matrix is 

being played.) Player 2 does not observe nature’s choice. These matrices are pictured here. 

A B 

1↓2 → L R 1↓2 → L R 

U 2, 2 0, 0 U 0, 2 2, 0 

D 0, 0 4, 4 D 4, 0 0, 4 

Solve for Bayesian Nash equilibrium. 

7. Consider a Cournot duopoly game with incomplete information. Suppose that demand is 

given by p = max{10 – Q, 0}, where Q is the total quantity produced in the industry. Firm 1 

selects a quantity q1, which it produces at zero cost. Firm 2’s cost of production is private 

information (selected by nature). With probability ½, firm 2 produces at zero cost. With 

probability ½, firm 2 produces with a marginal cost of 2. Call the former type of firm 2 “L” 

and the latter type “H” (for low and high cost, respectively). Firm 2 knows its type, whereas 

firm 1 knows only the probability that L and H occur. Let q2 H and q2 L denote the quantities 

selected by the two types of firm 2. Then when firm 2’s type is L, its payoff is given by u2 L = 

(10 – q1 – q2 L )q2 L . When firm 2’s type is H, its payoff is u2 L = (10 – q1 – q2 H )q2 H – (2q2 H ). As a 

function of the strategy profile (q1; q2 L , q2 H ), firm 1’s payoff is u1 = ((10 – q1 – q2 L )q1)/2 + 

((10 – q1 – q2 H )q1)/2. Solve for Bayesian Nash Equilibrium.

In Class Exercises Problem 1 A group of n students go to a ...

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