Durham University Business School

Department of Economics and Finance

ECON44115: Game Theory
Summative Assignment 2019-2020

Answer both questions.

Question 1 (50 marks)

Two …rms (i = 1; 2) compete for pro…ts in a homogeneous good industry. In the …rst stage
of competition, each …rm simultaneously chooses between a safe technology, S, and a risky
technology, R. The safe technology’s marginal cost of production is m with certainty. The
other technology is risky because it depends on some infrastructure that may, or may not,
be provided exogenously by the government. The risky technology’s marginal cost is ` with
probability and h with probability 1 where 0 < ` < m < h and 0 < < 1. Fixed costs
are zero for both technologies. After …rms choose technologies, they observe each other’s
choice. Then in the second and …nal stage of competition they simultaneously choose their
output levels, q1 and q2 , with output chosen before the exogenous infrastructure outcome.
Inverse demand is P = a b(q1 + q2 ) with a > h. Let Ti 2 fS; Rg denote …rm i’s technology
choice. Each …rm seeks to maximize expected pro…ts, denoted i (T1 ; T2 ; q1 ; q2 ).

(a) Derive expressions for the …rms’expected pro…ts. (10 marks)

(b) Solve for the …rms’optimal second stage output levels, conditional on their …rst stage
technology choices. Explain your work. (15 marks)

(c) Identify the parameter restriction(s) that must be satis…ed for the existence of a pure
strategy subgame perfect Nash equilibrium in which the …rst stage outcome is T1 = S
and T2 = R. Explain your work. (25 marks)

Question 2 (50 marks)

A mining …rm needs the services of a drilling …rm to extract minerals. The mining …rm
privately knows whether the value of minerals V is lots V or little V , but the drilling …rm
only knows that V occurs with probability p and V occurs with probability 1 p. The drilling
…rm recently invented a new drill bit— the tundra torque— and it privately knows whether
its drilling costs C will be lots C or little C, while the mining …rm only knows that C occurs
with probability q and C occurs with probability 1 q. Assume 0 < C < V < C < V ,
0 < p < 1, and 0 < q < 1.
The game is as follows. In the …rst stage the mining …rm o¤ers a share s 2 [0; 1] of the
value of minerals to the drilling …rm, with the remaining share 1 s held by the mining
…rm. Then in the second stage the drilling …rm chooses whether to accept or reject the o¤er.

1/4
If the o¤er is rejected, both …rms earn zero pro…ts. Finally, after the second stage, nature
reveals V to everyone whereupon the share o¤er is honored if it was accepted. Both …rms
seek to maximize expected pro…ts. The structure of the game is common knowledge. Find
a pure strategy perfect Bayesian equilibrium. Is it the only perfect Bayesian equilibrium?
Explain your work.

2/4
 SUBMISSION INSTRUCTIONS

Overall word limit: 2000 words maximum

The word count

includes all the text, including title, preface, introduction, in-text citations, quotations,
footnotes, and any other items not speci…cally excluded below;

excludes diagrams, tables, equations, mathematical symbols, bibliography, and appen-

dices. However, it is not appropriate to use diagrams or tables merely as a way of
circumventing the word limit — if a student does this, the diagrams/tables will be
included in the word count.

Examiners will stop reading once the word limit has been reached, and work beyond this
point will not be assessed. Checks of word counts will be carried out on submitted work,
including any assignments that appear to be clearly over-length. Checks may take place
manually and/or with the aid of the word count provided via an electronic submission.
Where a student has intentionally misrepresented their word count, Durham University
Business School may treat this as an o¤ence under Section IV of the General Regulations
of the University of Durham. Extreme cases may be viewed as dishonest practice under
Section IV, 5(a)(x) of the General Regulations.

Very occasionally it may be appropriate to present in an appendix material which does

not properly belong in the main body of the assessment but which some students wish to
provide for the sake of completeness. Any appendices will not have a role in the assessment
— examiners are under no obligation to read appendices and they do not form part of the
word count. Material that students wish to be assessed should always be included in the
main body of the text.

YOUR COMPLETED ASSIGNMENT MUST BE SUBMITTED TO DUO NO

LATER THAN 11:59 AM ON MONDAY 11 MAY 2020.

MARKING GUIDELINES

Performance in the summative assessment for this module is judged against the following
criteria:

relevance to questions;

organization, structure, and presentation;

3/4
 depth of understanding;

analysis and discussion;

use of sources and referencing;

overall conclusions.

Students should use the template on DUO for their assignments. Hand written answers may
be scanned and inserted onto the template, provided they are clearly legible. All appendices
should be included with the submission.

Guidance on referencing can be found in your assessment handbook under “Things You Need
to Know”on DUO.

PLAGIARISM AND COLLUSION

Students suspected of plagiarism, either of published work or the work of other students, or of
collusion will be dealt with according to Durham University Business School and University
of Durham guidelines.

Your assignment will be put through the plagiarism detection service.

4/4