ECON401: Problem Set 6.
3
© 2023 Noriko Ozawa
ECON401: Applied Microeconomic Analysis
Problem Set 6.3: Bayesian Games
1. Consider the Bayesian game below. Nature chooses the types of Player 1, where Type H occurs
with probability p and Type L with probability 1 – p. Player 1 learns his type and then chooses
either action Up or action Down. Simultaneously, Player 2 chooses either action R or action L.
N
Pr(t = H) = p Pr(t = L) = 1 – p
1H 1L
Up Down Up Down
2’s info set
L R L R L R L R
u1 3 1 2 5 2 1 3 4
u2 = 2 1 0
1 3 1 2 3
a) Assume that p = 0.75. Find a BNE
b) For each value of p, find all BNEs.
2. Consider a first-price, sealed-bid auction in which a bidder’s valuation can take only one of three
values: 5, 7 and 10, occurring with probabilities 0.2, 0.5 and 0.3, respectively. There are two
bidders, whose valuations are independently drawn by Nature. After each bidder learns her
valuation, they simultaneously choose a bid that is required to be a positive integer. A bidder’s
payoff is zero if she loses the auction and is her valuation minus her bid if she wins it.
a) Determine whether it is a symmetric BNE for a bidder to bid 4 when her valuation is 5, 5
when her valuation is 7 and 6 when her valuation is 10.
b) Determine whether it is a symmetric BNE for a bidder to bid 4 when her valuation is 5, 6
when her valuation is 7 and 9 when her valuation is 10.
3. Consider a first-price, sealed-bid auction with three bidders. Assume that the item has the same
value to all three bidders, but they receive different signals as to its value. Nature first chooses the
true value, denoted by v, where v (4, 5, 6). Each of these values is chosen with probability 1/3.
The signals sent to the bidders are v – 1, v, and v + 1. Each bidder learns only his own signal,
which is the bidder type. Given the value, each bidder has an equal chance of receiving one of the
three signals. The minimum increment in bidding is 1, so that the set of feasible bids is (0, 1, 2, …,
10). The payoff to a bidder is 0 when he does not win the auction, and is the true value of the item
minus his bid when he is the winner. If two or more bidders submit the highest bid, then the winner
is randomly determined.
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ECON401: Problem Set 6.3
© 2023 Noriko Ozawa
Show that the following symmetric strategy profile is a BNE.
When the signal is 3, 4, 5, and 6, submit a bid of 4.
When the signal is 7, submit a bid of 5.
If v = 4, then one bidder is given a signal of 3, another bidder is given a signal of 4 and the last
bidder is given a signal of 5. If v = 5, then one bidder is given a signal of 4, another bidder is given
a signal of 5 and the last bidder is given a signal of 6. If v = 6, then one bidder is given a signal of
5, another bidder is given a signal of 6 and the last bidder is given a signal of 7.
4. Consider two pharmaceutical firms investing in R & D. Each firm can invest either a low (L),
medium (M), or high (H) rate. For any pair of investment rates, Firm 1’s profit is known but Firm
2’s profit is private information because only Firm 2 knows the cost that it incurs. Firm 2 either has
low cost or high cost. The payoff matrix for each case is shown below. Assume the probability
that company 2 is low cost is p and is high cost is 1 – p.
Case 1: Firm 2 has low cost, p Case 2: Firm 2 has high cost (1 – p)
Firm 2 Firm 2
L M H L M H
L 7, 12 5, 15 4, 16 L 7, 3 5, 4 4, 0
Firm 1 M 9, 10 6, 12 3, 11 Firm 1 M 9, 2 6, 0 3, -4
H 8, 8 4, 9 0, 8 H 8, 0 4, -3 0, -8
Nature chooses Firm 2’s type and then the two companies simultaneously choose investment rates.
Find all BNE.
5. Consider the game shown on the top of the next page. Nature chooses Player 1’s type to be L1 with
probability p1 and H1 with probability 1 – p1, and chooses Player 2’s type to be L2 with probability
p2 and H2 with probability 1 – p2. After players learn their type, they simultaneously choose
actions; Player chooses between a and b, and Player 2 between c and d.
a) If Player 1 chooses a for either type, derive Player 2’s optimal strategy (best-response) as
function of p1 and p2.
b) Derive conditions on p1 and p2 such that it is a BNE for Player 1 to choose a for either type
and Player 2 to choose c for either type.
c) Assume p1 = 0.4 and p2 = 0.3. Find all of the BNE.
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ECON401: Problem Set 6.3
© 2023 Noriko Ozawa
N
Pr(t1= L1) = p1 Pr(t1 = H1) = 1 – p1
N N
Pr(t2= H2) = 1– p2 Pr(t2= H2) = 1– p2
Pr(t2= L2) = p2 Pr(t2= L2) = p2
1’s info set 1’s info set
aL bL aH bH
2’s info set
dL dL dL dL
cL cL cL cL
u1 2 3 4 1 aL bL 0 5 1 4 aH bH
u2 = 5 1 4 0 3 4 6 3
2’s info set
dH dH dH
cH cH dH cH cH
3 2 0 0 3 3 2 3
2 6 3 4 5 0 2 0
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ECON401: Problem Set 6.3
© 2023 Noriko Ozawa
6. Consider a game between an extortionist and the victim. The extortionist is one of two types: with
probability 1 5 he is crazy and with probability 4 5 he is sane. When the victim pays, the payoff of the
extortionist, whether he is crazy or sane, is 2, whereas the payoff of the victim is zero. When the
victim does not pay, her payoff is -1 if the extortionist explodes the grenade and 1 if he does not. The
crazy extortionist gets a payoff of 1 if he explodes the grenade and -1 if he does not. The sane
extortionist, however, gets a payoff of -1 from exploding the grenade and 1 if he does not.
N
4 1
5 5
V1’s I
Not pay Pay Not pay Pay
2S 2C
0 0
Not 2 2
explode Explode Not
Explode
explode
uV 1 1 1 1
uE 0 1 1 1
a) Verify that the victim would not pay in a one-shot game.
Suppose that the extortion game described above is repeated twice – a single extortionist approaches
two victims sequentially.
b) Explain why “Not explode” in the first period cannot be part of an equilibrium strategy for the
sane extortionist.
c) In the perfect Bayesian equilibrium (PBE) of the twice-repeated extortion game, the second
victim randomizes over paying and not paying if the extortionist exploded in the first period.
Let p be the probability that the second victim pays given that the extortionist exploded in the
first period (so, p is the posterior belief of the second victim). As well, in this equilibrium, the
sane extortionist randomizes over exploding and not exploding in the first period. Let q be the
probability that the sane extortionist explodes in the first period. Find p and q.
d) Summarize the PBE.
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ECON401: Problem Set 6.3
© 2023 Noriko Ozawa
7. Consider an entry game between an incumbent (I) and an entrant (E). There are two types of
incumbents, strong and weak, denoted by respectively IS and IW in the diagram below. The
incumbent knows its own type but the entrant only knows that with probability 1 the incumbent
6
is of strong and with probability of 5 it is of weak. The extensive form of the game is shown
6
below.
N
1 5
6 6
E’s I
In Out In Out
IS IW
0 0
Fight 4 Fight 4
3.5
Accommodate Accommodate
E 12 1 12 1
1 1
1
I 2 0 162 162
a) Find the subgame perfect Nash equilibrium of this entry game.
b) Suppose that this entry game is repeated twice – a single incumbent faces sequential entries of
two entrants. If the second entrant observes the incumbent’s action in period 1 before making
its entry decision, and the incumbent knows this, then does either type of incumbents have an
incentive to change its strategy? If so, why?
c) In the perfect Bayesian equilibrium (PBE) of the twice-repeated reputation game, the second
entrant randomizes over “In” and “Out” if the incumbent fought in first period. Let p be the
probability that the second entrant chooses “Out” given that the incumbent fought in the first
period (so, p is the posterior belief of the second entrant). As well, in this equilibrium, the
weak incumbent randomizes over “Accommodate” and “Fight” in the first period. Let q be the
probability that the weak incumbent fought in the first period. Find p and q.
d) Summarize the PBE.
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ECON401: Problem Set 6.3
© 2023 Noriko Ozawa
8. Consider a variant of the two-period reputation model discussed in the class. Let be the probability
of the incumbent being strong.
N
1
E’s I
In Out In Out
Is 0 Iw 0 E
3 3 I
Fight Fight
Accommodate Accommodate
1 1 1 1
2 0 0 2
Characterize the perfect Bayesian equilibrium of this game, in particular:
i. What would the weak incumbent do if entry occurred in the second period?
ii. What would the second entrant do if the entry was accommodated in the first period?
iii. Let p be the probability that the second entrant stays out if the entry was fought in the first
period. Find p.
iv. Let q be the probability that the weak incumbent fights the entry in the first period. Find q as a
function of
v. Under what circumstance will the first entrant enter? (that is, what is the prior belief of the
first entrant that makes her expected payoff from entering to be positive?)
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