ECON-602

Problem Set 1 - Solutions

1. Problem 5.3

Let W t be the set of all Nash continuation payoff vectors in a subgame starting in period t
0
with history ht . The question is asking to prove that W t = W t for all t, t0 . If w is a Nash
continuation payoff vector, since w : ni=1 (si ) Rn , it suffices to show that the Nash
strategy space is identical in each proper subgame. We do this, as the question suggests, by
creating a map between the whole game and a subgame.

Let s be strategies in subgame with history ht and let s be strategies for the entire game, such
that

s(ht ) =s(h0 )
s(ht , at ) =s(at )
s(ht , at , at+1 ) =s(at , at+1 )
..
.

and

s(h0 ) =s(ht )
s(a0 ) =s(ht , a0 )
s(a0 , a1 ) =s(ht , a0 , a1 )
..
.

Let (s(h0 ), ...) be a Nash equilibrium of the whole game. By the definition of a Nash equilibrium

X X 0 0
(1 ) T ui (s(hT )) (1 ) T ui (si (hT ), si (hT ))si
T =0 T =0

X X 0 0
(1 ) T ui (s(ht+T )) (1 ) T ui (si (ht+T ), si (ht+T ))si
T =0 T =0

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 Which implies that (s(ht ), ...) is a Nash equilibrium in the subgame, ht .

Conversely, let (s(ht ), ...) be a Nash equilibrium of the subgame ht . Again, by the definition of
a Nash equilibrium

X X 0 0
(1 ) T ui (s(ht+T )) (1 ) T ui (si (ht+T ), si (ht+T ))si
T =0 T =0

X X 0 0
(1 ) T ui (s(hT )) (1 ) T ui (si (hT ), si (hT ))si
T =0 T =0

Which implies that (s(h0 ), ...) is a Nash equilibrium in the whole game. 

2. Problem 5.5
(a) In a subgame-perfect equilibrium, a Nash equilibrium of the second period game must
be played after each possible history. One type of subgame-perfect equilibrium is to play
(D1, R1) then any of the static equilibria (U2, L2), (D2, R2) or ( 34 U 2, 14 L2).

If a non-equilibrium is played in period 1 it must be supported by punishing a player

who deviates. This gives equilibria with payoffs (3, 1) [(1, 3)] then (4, 6) [(6, 4)]. The
equilibrium with payoff (6, 4) [(4, 6)] or the equilibrium with payoff (3.75, 3.75) follows a
deviation by player 2.

The convex hull is the pentagon bounded by the extreme points (3.75, 3.75), (6,4), (7,5),
(5,7) and (4,6).
(b) If the players observe a random variable y1 , a SPE is formed by having the players play
a subgame-perfect equilibrium of the original game after each possible observation. We
can use a different SPE after each y1 , so we can obtain any payoff which is a convex
combination of the payoffs in (a). This is precisely the set given in the answer to part (a).
(c) If players observe y2 at the start of the second period, the second period payoff can be any
point in the convex hull of (6, 4), (4, 6) and (3.75, 3.75). After each realization of y1 , one
of the subgame-perfect equilibria of the continuation game must be played. They are
(0,0) then any 2nd period equilibrium.
(2,2) then any 2nd period equilibrium with payoff 4.75 for each player.
(3, -1) then any 2nd period equilibrium with payoff 4.75 for player 2.
(-1, 3) then any 2nd period equilibrium with payoff 4.5 for player 1.
Note that this gives new payoffs like (7,7) which were not in the sets in parts (a) and (b),
because the randomization y2 allows us to specify an equilibrium with payoff (5,5) if (U1,
L1) is played in period 1. This allows us to punish either player sufficiently strongly to
prevent a deviation.

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3. Problem 5.8
(a) For any NE, , construct a new strategy, 0 as follows.

Phase I : All players play according to as long as no single player deviates.

Phase II(i): If player i deviates, play i .

0
To show that is a SPE, in Phase II(i) SPE i is played, hence no player has incentive
to deviate in Phase II(i). In Phase I, suppose player j can profitably deviate from 0 by
0 0 0
playing j at some history ht . (We can assume that j differs from j only in period t).
We construct a profitable deviation j from the Nash equilibrium j by having player j
play according to j as long as ht has not been reached, according to j at ht and playing
a best response to j at all subsequent histories. This implies

0
Uj (j , j ) = Uj (j , j ) + [Uj (j , j |ht ) Uj (j , j |ht )]
> Uj (j , j )

The second inequality follows because in period t the gain from deviating is exactly the
0 0
same as was the gain from playing j instead of j . This contradicts the fact that is a
NE.
(b) Let be a Nash equilibrium of the repeated game. We form a subgame perfect equilibrium
as follows:

Phase I: Players play according to as long as no player i has deviated. If player i

deviates go to Phase II(i).
Phase II(i): All players play mi in each period. If some player, say j, deviates in this
phase, play moves to Phase II(j).

Checking incentives:
Phase II(i): Player i has no profitable deviation since player i is being minmaxed. Player
j will not deviate as long as

gj (mi ) (1 )uj ( j , mij ) + v j

uj ( j , mij ) gj (mi )
=
uj ( j , mij ) v j

Since gj (mi ) > v j this guarantees < 1. Phase I: Proof as in part (a).

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