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    Aparna Howlader
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    This document provides a solution to a dynamic game problem using backward induction. It analyzes the objectives and constraints of both the parent and child at different stages. The solution shows that maximizing the individual objectives of parent and child leads to the same outcome as jointly maximizing their total income, satisfying the first-order condition of their combined income maximization problem.

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    This document provides a solution to a dynamic game problem using backward induction. It analyzes the objectives and constraints of both the parent and child at different stages. The solution shows that maximizing the individual objectives of parent and child leads to the same outcome as jointly maximizing their total income, satisfying the first-order condition of their combined income maximization problem.

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    58 views2 pages

    Ps 4 Solution

    Uploaded by

    Aparna Howlader
    This document provides a solution to a dynamic game problem using backward induction. It analyzes the objectives and constraints of both the parent and child at different stages. The solution shows that maximizing the individual objectives of parent and child leads to the same outcome as jointly maximizing their total income, satisfying the first-order condition of their combined income maximization problem.

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    Problem Set 4 Solution

    17.881/882 October 26, 2004

    Gibbons 2.1 (p.130)

    This is a dynamic game of perfect information, we will use backward induction to solve. We start at the nal stage. The parents objective is max V (Ip (A) B ) + kU (Ic (A) + B )
    B

    The rst-order condition is: V 0 (Ip (A) B ) + kU 0 (Ic (A) + B ) = 0 (1)

    (Ill omit discussion of the second-order condition). This equation is dening an implicit relation B (A). In the rst stage, the child anticipates his choice of A to aect B according to 1. The childs problem is max U (Ic (A) + B (A))
    A

    The rst-order condition is:


    0 (A) + B 0 (A)] = 0 U 0 (Ic (A) + B )[Ic

    (2)

    (Ill omit discussion of the second-order condition). Since U 0 > 0, the only way for 2 to hold is to have
    0 Ic (A) = B 0 (A)

    (3)

    To nd B 0 (A), let us use the implicit function theorem on 1.


    00 0 V 00 Ip + kU 00 Ic dB = dA V 00 + kU 00

    0 Using 3, and solving for Ic , we nd 0 0 V 00 [Ic (A) + Ip (A)] = 0 0 0 Since V is strictly concave, this can only hold if Ic (A) + Ip (A) = 0, which is exactly the rst-order condition of the joint-income maximization problem:

    max Ic (A) + Ip (A)


    A

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