Problem set 1

GTA

Question 1

We looked at median voter theorem in the class with two players. We showed that it is dominant (in
an iterated sense) for both players to play in the middle. What happens when there are three
players? I understand the answer is not straightforward, but the idea is for you to think about it…

Question 2

In the class I made reference to a paper on mixed strategy Nash equilibrium: ‘Experiencia Docet:
Professionals Play Minimax in Laboratory Experiments,’ by Ignacio Palacios-Huerta and Oscar Volij.
Critique that paper. Specifically, address the following questions (but need not limit to them only): A.
What are the authors trying to prove? B. Are the methods they chose appropriate? C. What aspects
of the paper do you like? D. What do you think are the problems with the paper? E. How do those
problems affect the conclusions the authors draw in the paper? F. Finally, if you were the one that is
writing the paper, how would it be different?

Question 3

Very difficult one, but again, it is the effort!

Suppose two firms compete in setting prices. Marginal costs of both firms are normalized to zero.
There are two types of consumers: Informed and Uninformed. Specifically, there are I informed
consumers and 2U uninformed consumers. Informed consumers shop at the place that has least
price in the market. Uninformed consumers are not aware of the prevailing prices, and shop at a
random store. Therefore, U of them shop at Firm 1 and U of them shop at Firm 2. Assume that the
reservation price for each consumer is r.

If U = 0, what is the equilibrium?

Is it possible to have a pure strategy Nash equilibrium if U>0? Why? Or why not?

If there is no pure strategy NE, does mixed strategy NE exist? What could that be?

Question 4

We look at a classic problem called the Problem of Commons! Imagine there are n individuals whose
utility is given by:

ln(𝑓𝑖𝑟𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛) + ln(𝑠𝑒𝑐𝑜𝑛𝑑 𝑝𝑒𝑟𝑖𝑜𝑑 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛)

In Period 1, an individual, i, consumes 𝑐𝑖 . In the second period, each individual consumes an equal
fraction of what remains after first period consumption. That is, second period consumption of each
𝑌−∑𝑛
𝑖=1 𝑐𝑖
individual is given by: . For the sake of simplicity, I assume that there is no discounting of
𝑛
future consumptions (not that the answer changes if it is different). How much does each individual
consume in Nash equilibrium?
If, on the other hand, government sets constraints on how much each person can consume in Period
1, what should the government choose as first period consumption?

Contrast the consumption in both settings.

Question 5

Here is question that discusses product differentiation in Nash equilibrium terms. Based on the
classroom comments, some of you might have a bit of head start in this.

Imagine there is a circular city with circumference of one unit. There are n firms located uniformly
over the circle (equidistant from each other) that sell the same product. Consumers are uniformly
located across the circumference of the circle. They all value the product very highly. Say, the
valuation is V, which is fairly large. Each of them incur a transportation cost of ‘t’ for every unit
distance travelled. You may assume that a consumer purchases product from a store that maximizes
his/her utility, which is given by 𝑈𝑖 = 𝑉 − 𝑝 − 𝑡𝑥, where p is the price paid, and x is the distance
travelled by the consumer. As already assumed, V is large enough, which implies consumer
purchases from somewhere. Figure out the Nash equilibrium prices in the market if utility of
consumer is V minus price paid minus transport cost incurred.

Question 6 – Here is a fun problem

Tell me, my daughters

Since now we will divest us both of rule
Interest of territory, cares of state,
Which of you shall we say doth love us most?
That we our largest bounty may extend
Where nature doth with merit challenge
-- King Lear in King Lear (Act 1, Scene 1)

King Lear was worried about how his children would treat him in his old age. Much to his regret, he
discovered that children do not always deliver what they promise. In addition to love and respect,
his children are also motivated by the possibility of inheritance.
Forget about the actual story of King Lear. He has three daughters. He would prefer if the daughters
come and visit him once and phone twice a week. In order to incentivize their visits, he threatens to
disinherit any child who fails to meet this quota. His kingdom would be equally divided among his
daughters that meet this quota. This is an amazing scheme because that way he ensures that his
daughters visit him often enough, BUT NOT TOO OFTEN…
There is only one catch here. He really does not want his kingdom to pass on to strangers. Therefore,
he will not want to disinherit all three of them. Visiting and phone calls are costly business because
the daughters live sufficiently far away. (Historical records suggest that long distance calls and
travels are notoriously expensive in those days.) Therefore, they find it very expensive to meet the
quota requirements. Since they know that King Lear would not disinherit all of them, they get
together and agree that they are going to cut down the visits/phone calls substantially (even to
zero).

His Majesty Lear realized this, and decided to hire a consultant to help him solve this conundrum. He
heard that in IIMA Prof. Pingali teaches a super course in game theory and decided to hire one of his
students as the consultant. As it turns out, the person he hired was you. What would you advise
him?

Assume: Phone and visit are equally expensive. King Lear treats phone call and visit equally
enjoyable. Also assume all three daughters prefer full kingdom to half kingdom to one third kingdom
to no kingdom. Ignore all present value of money business…

I am not looking for a very precise answer here. I am just wondering how you would analyse this
situation.