PROBLEM SET 5 ECON 309 – Game Theory

Instructions:

▪ The assignment is due by midnight (23:59PM, ET) on Saturday, April 24th.

▪ Submit your assignments on Moodle as a pdf. file. You can scan your handwritten assignments by using
your phone—there are free scanning apps available for android and ios.
▪ Show your work and explain your reasoning clearly.
▪ Unless otherwise stated in a question, when modeling an interaction and assigning payoff numbers, assign
“0” to the least preferred outcome, “1” to the next best and so on. As discussed in class, since the payoff
numbers represent only the preference-ranking of the outcomes, this will not affect the answer. It will make
your answer and the solutions consistent, thus make your reporting and my grading easier.
▪ Unless otherwise stated in a question, the players are assumed to have self-regarding preferences.
▪ When conducting best-response analysis, you can simply mark your analysis (i.e. the best-responses of
each player) on the payoff matrix or game tree. You do not need to provide a verbal explanation. Make
sure your markings are clear.
1) [50 points] Consider your “dream job”, that is the job that you are hoping to ultimately get upon graduation.
Answer the questions below accordingly. (This may be a job you have already applied for or one that you
are planning to apply. If neither applies to your situation, answer the question for any specific job you
pick.)

Provide reference for the information you use (e.g. link to the website for the job-ad that you are considering)
for each one of your answers. Include specific weblinks that the information you are using is drawn from. In
addition, save the corresponding pages and include the saved pages in your assignment (you may include them
all at the end or alongside the corresponding question).

If you have additional information that is not listed on the webpage, e.g. information you gathered through
your conversations with someone who works at that company, you may use that information as well in
answering the questions—make sure to note explicitly the source of the information (reference) you are
referring to in your answers.

1. State the job that you picked and the job description, i.e. the responsibilities of the position.
2. What screening strategy/strategies does the employer use? Hint: What are the application requirements
listed in the job-ad, and that you know of from other sources, if any, even though they are not specified
on the ad?
3. For each screening strategy you identify in (2) explain which hidden characteristic of the job candidates
the strategy is aimed at uncovering.
4. For each screening strategy you identify in (2) explain whether you think the strategy will be successful
in inferring the hidden characteristic it aims at uncovering, that is whether it will achieve a separating
equilibrium.
5. What signaling strategies are you planning to use (or did you use if you have already applied) when
applying for this job?
6. For each signaling strategy you identify in (4) explain which hidden characteristic of yourself you aim
at signaling.
7. For each signaling strategy you identify in (4) explain why you consider the signal to be credible.
2) [25 points] Suppose you are the owner of a company that is undertaking a new project. You have to hire a
manager to supervise it. The success of the project is uncertain, but good supervision by the manager can
increase the probability of success. The value of a successful project is 800 units. The project is still worth
200 units even if it is not successful in achieving all the projected goals. The probability of success in case
of high effort by the manager is 0.7 (accordingly, the probability of not being successful is 0.3); and the
probability of success in case of low effort by the manager is 0.3 (accordingly, the probability of not being
successful is 0.7). The cost (disutility) of high effort to the manager is equivalent to 20 units and that of
low effort is equivalent to 4 units. The manager has an alternative employment opportunity that would
offer him a fixed wage of 10 units.

As the owner of the company, you are to come up with the best incentive scheme to offer to this manager.
The manager’s payoff is given by the payment he receives minus the cost (disutility) of effort. Your payoff is
given by your expected profits (that is, expected value of the project minus the wage paid to the manager).
Suppose you can choose between a fixed-wage scheme and a wage-plus-bonus scheme. (Consider the wage-
plus-bonus scheme we discussed in class; i.e. the manager is paid a low wage if the project fails, i.e. yields the
low value, and a high wage if the project succeeds, i.e. yields the high value. To make sense of the numbers,
you can think of a unit as $1,000, but for simplicity work with the unit numbers as defined in the question
rather than converting them to dollar amounts.)

a. [10 points] What would be the fixed wage you would offer under a fixed-wage scheme? What would
be the expected payoffs to you and the manager under this scheme?
b. [15 points] What would be the levels of low wage (paid when the project fails) and high wage (paid
when the project succeeds) you would offer in a wage-plus-bonus scheme? What would be the expected
payoffs to you and the manager under this scheme?
3) [25 points] There are two routes for driving from A to B. One is a freeway, and the other consists of
local roads. The benefit of using the freeway is constant and equal to 1.8, irrespective of the number of
people using it. Local roads get congested when too many people use this alternative, but if not enough
people use it, the few isolated drivers run the risk of becoming victims of crimes. Suppose that when a
fraction x of the population is using the local roads, the benefit of this mode to each driver is given by

1 + 9x – 10x2

a. [5 points] Draw a graph showing the benefits of the two driving routes as functions of x,
regarding x as a continuous variable that can range from 0 to 1. (Use x as the horizontal axis
as the figures in the textbook. You can use a graphing calculator or online tools to graph and
solve the quadratic equation.)
b. [15 points] Identify all possible equilibrium traffic patterns from your graph in part (a).
Which equilibria are stable? Which ones are unstable? Why? You need to explain your
reasoning to get credit.
c. [5 points] Write the function representing total social payoff to the whole population.