BE

510 Business Economics 1 - Autumn 2021

Problem Set 6

1. Find all mixed-strategy Nash equilibria of game (a) in Problem Set 2 – Question 1:
Player 2
Left Centre Right
Up 350, 350 350, 250 1000, 0
Player 1 Middle 250, 350 550, 550 0, 0
Down 0, 1000 0, 0 500, 500

2. Determine the mixed-strategy Nash equilibria of the two games discussed in Problem Set 2 –
Question 2. Suppose that these equilibria are played. What is the most likely outcome in each
game? When is it more likely that Alice and Bob meet – when Alice wants to meet Bob or when
she wants to avoid him?

Original game: Bob Modified game: Bob

Ballet Football Ballet Football
Ballet 3 , 2 1 , 1 Ballet 1 , 2 3 , 1
Alice Alice
Football 0 , 0 2 , 3 Football 2 , 0 0 , 3

3. Find all the Nash equilibria of the following game.

Player 2
Left Centre Right
Up 4, 2 0, 1 0, 0
Player 1 Middle 0, 0 1, 3 2, 4
Down 0, −9 2, 0 −1, −1

4. Consider the following symmetric, infinitely repeated, simultaneous-move game.

Player 2
Left Centre Right
Up 12, 12 –10, 27 –10, 0
Player 1 Middle 27, –10 5, 5 0, 𝑥
Down 0, –10 𝑥, 0 10, 10

Both players discount the future according to the discount factor 𝛿 = 3⁄5. Choose 𝑥 such that
the Up-Left cell can be sustained under a suitable trigger strategy.

Problem Set 6 - Solutions BE 510 Business Economics 1 - Autumn 2021

Problem Set 6 - Solutions

No guarantees for correctness. If you find errors in the proposed solutions, please let us know.

1. Find all mixed-strategy Nash equilibria of game (a) in Problem Set 2 – Question 1:
Player 2
Left Centre Right
Up 350, 350 350, 250 1000, 0
Player 1 Middle 250, 350 550, 550 0, 0
Down 0, 1000 0, 0 500, 500

Down and Right can never be played in a mixed-strategy equilibrium (MSE) because they are
strictly dominated by Up and Left. Furthermore, there is no MSE where one player chooses
one of the actions with certainty and the other one randomizes because given that one player
chooses an action with certainty there is always a single best response for the other player.
Hence, there is only one possibility for a MSE: P1 randomizes between Up and Middle, and P2
between Left and Centre. Say that P2 chooses Left with probability 𝑝 and Centre with
probability 1 − 𝑝. Then P1 is indifferent between Up and Middle if 350 = 250𝑝 + 550(1 − 𝑝)
or 𝑝 = 2⁄3. The game is symmetric and so P2 is indifferent between Left and Centre when P1
picks Up with probability 𝑞 = 2⁄3 and Middle with probability 1 − 𝑞 = 1⁄3. Thus, there is a
MSE (a unique MSE) in which P1 chooses Up with probability 2⁄3 and Middle with probability
1⁄3 , and P2 chooses Left with probability 2⁄3 and Centre with probability 1⁄3 . In this
equilibrium both players expect to earn 350.

2. Determine the mixed-strategy Nash equilibria of the two games discussed in Problem Set 2 –
Question 2. Suppose that these equilibria are played. What is the most likely outcome in each
game? When is it more likely that Alice and Bob meet – when Alice wants to meet Bob or when
she wants to avoid him?

Original game: Bob Modified game: Bob

Ballet Football Ballet Football
Ballet 3 , 2 1 , 1 Ballet 1 , 2 3 , 1
Alice Alice
Football 0 , 0 2 , 3 Football 2 , 0 0 , 3

In the original game Alice chooses Ballet with probability 3⁄4 and Bob chooses Ballet with
probability 1⁄4. The total chance of a meeting either at the football stadium or in front of the
ballet theatre is 2 × (3⁄4) × (1⁄4) = 3⁄8 = 0.375. However, the most likely outcome is that
Alice goes to the ballet and Bob to the football (probability 0.5625).
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Problem Set 6 - Solutions BE 510 Business Economics 1 - Autumn 2021

In the second game, the one where Alice seeks to avoid Bob, Alice chooses Ballet with
probability 3⁄4, as before, but Bob now picks Ballet also with probability 3⁄4. Now the most
likely outcome is that they meet at the ballet performance (probability 0.5625). Their chance
of meeting at the football stadium is 0.0625. Thus, the total chance of meeting is 0.625, much
higher than in the original game.

3. Find all the Nash equilibria of the following game.

Player 2
Left Centre Right
Up 4, 2 0, 1 0, 0
Player 1 Middle 0, 0 1, 3 2, 4
Down 0, −9 2, 0 −1, −1

There are three pure-strategy equilibria: (Up, Left), (Middle, Right) and (Down, Centre).
Mixed strategy Nash equilibria (MSEs):
There can be no MSE where one player chooses any of her actions with certainty and the other
randomizes, because whenever one player chooses an action with certainty the other player
has only a single best response and therefore should not randomize. However, there are many
other possibilities. There could be MSEs where both players randomize among two of the
three actions, or where one player randomizes between two of the three actions and the other
between all three actions, or where both players randomize over all three actions.
(1) Suppose P2 randomizes between Left and Centre but never picks Right. Given that Right
is never chosen, Middle is dominated by Down and must not be chosen by P1, but
randomizing between Up and Down could be a best response. Conversely, given that P1
randomizes between Up and Down, Right is dominated by Centre but randomizing
between Left and Centre could be a best response. We have to give this further thought.
If P2 chooses Left with probability 𝑝 and Centre with probability 1 − 𝑝, P1’s expected
payoff from choosing Up is 4𝑝 and his expected payoff from choosing Down is 2 − 2𝑝.
These are equal if 𝑝 = 1⁄3. Conversely, if P1 chooses Up with probability 𝑞 and Down
with probability 1 − 𝑞, P2’s expected payoff from choosing Left is 2𝑞 − 9(1 − 𝑞) = 11𝑞 −
9 and her expected payoff from choosing Centre is 𝑞. These are equal if 𝑞 = 9⁄10.
Thus, there is a Nash equilibrium in which P1 picks Up with probability 𝟗⁄𝟏𝟎 and
Down with probability 𝟏⁄𝟏𝟎 and P2 chooses Left with probability 𝟏⁄𝟑 and Centre
with probability 𝟐⁄𝟑. In this equilibrium P1 obtains an expected payoff of 4⁄3 and P2
receives an expected payoff of 0.9. Neither Middle nor Right are profitable deviations.

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Problem Set 6 - Solutions BE 510 Business Economics 1 - Autumn 2021

(2) Now suppose P2 randomizes between Left and Right. Given that P2 never takes Centre,
Down is dominated by Middle and must not be chosen by P1, but randomizing between
Up and Middle could be a best response. Conversely, given that P1 randomizes between
Up and Middle, there is no dominance relationship between Left and Right. Centre is not
dominated by either Left or Right although Centre never is a best response. Thus,
randomizing between Left and Right could be a best response but we must keep an eye
on the possibility of a profitable deviation to Centre.
If P2 chooses Left with probability 𝑝 and Right with probability 1 − 𝑝, P1’s expected
payoff from Up is 4𝑝 and P1’s expected payoff from Middle is 2 − 2𝑝. These are equal if
𝑝 = 1⁄3. Conversely, if P1 chooses Up with probability 𝑞 and Middle with probability 1 −
𝑞, P2’s expected payoff from Left is 2𝑞 and her expected payoff from Right is 4 − 4𝑞.
These are equal if 𝑞 = 2⁄3.
If these strategies are played, both players obtain expected payoffs of 4⁄3. Down is not a
profitable deviation for P1 but what about Centre for P2? Centre yields an expected payoff
of (2⁄3) × 1 + (1⁄3) × 3 = 5⁄3 and thus is a profitable deviation. Therefore, there is no
equilibrium where P2 is randomizing between Left and Right.
(3) Next, suppose P2 randomizes between Centre and Right. In this case Up is dominated by
Middle and cannot be chosen by P1. There is no dominance relationship between Middle
and Down, so randomizing between these could be a best response. Conversely, given
that P1 randomizes between Middle and Down, Left is dominated by both Centre and
Right and there is no dominance relationship between Centre and Right. Thus,
randomizing between Centre and Right could be a best response.
If P2 chooses Centre with probability 𝑝 and Right with probability 1 − 𝑝, P1’s expected
payoff from choosing Middle is 𝑝 + 2(1 − 𝑝) = 2 − 𝑝 and P1’s expected payoff from
choosing Down is 2𝑝 − (1 − 𝑝) = 3𝑝 − 1. These are equal if 𝑝 = 3⁄4. Conversely, if P1
chooses Middle with probability 𝑞 and Down with probability 1 − 𝑞, P2’s expected payoff
from choosing Centre is 3𝑞 and her expected payoff from choosing Right is 4𝑞 −
(1 − 𝑞) = 5𝑞 − 1. These are equal if 𝑞 = 1⁄2.

Thus, there is a Nash equilibrium in which P1 chooses Middle and Down with 50-
50 chance and P2 chooses Centre with a 75% chance and Right with a 25% chance.
In this equilibrium P1 obtains an expected payoff of 5⁄4 and P2 receives an expected
payoff of 3⁄2. Neither Up nor Left are profitable deviations.
(4) Finally, suppose P2 is randomizing over all three actions. In this case no action is
dominated for P1. If P2 chooses Left with probability 𝑝! and Centre with probability 𝑝" ,
P1’s expected payoff from choosing Up is 4𝑝! , from choosing Middle is 𝑝" + 2(1 − 𝑝! −
𝑝" ) = 2 − 2𝑝! − 𝑝" and from choosing Down is 2𝑝" − (1 − 𝑝! − 𝑝" ) = 𝑝! + 3𝑝" − 1.

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Problem Set 6 - Solutions BE 510 Business Economics 1 - Autumn 2021

There are different possibilities now. In principle, it is conceivable that P1 randomizes

between any two of the three actions or that P1 randomizes over all three actions.
However, we have seen above that when P1 randomizes only between Up and Down
(never choosing Middle) Right is dominated by Centre, and then P2 could not be
randomizing over all three actions. Similarly, when P1 randomizes only between Middle
and Down (never choosing Up) Left is dominated, and hence again P2 could not be
randomizing over all three actions. The only remaining possibilities are that P1
randomizes between Up and Middle or that P1 randomizes over all three actions. For
either case we would have to find probabilities such that P2 is indifferent over all her
actions—otherwise, once again, it would not make sense for her to randomize over them.
Case 1: P1 randomizes only between Up (probability 𝑞) and Middle (1 − 𝑞). In this case
P2 earns, in expectation, 2𝑞 from choosing Left, 𝑞 + 3(1 − 𝑞) from choosing Centre and
4(1 − 𝑞) from choosing Right. Is there a value for 𝑞 such that all three expected payoffs
are the same? The answer is no: 𝑞 = 2⁄3 equalizes the payoffs from Left and Right but
yields a greater payoff from Centre, and 𝑞 = 1⁄2 equalizes the payoffs from Centre and
Right but yields a lower payoff from Left. Thus, this doesn’t work.
Case 2: P1 randomizes over all three actions, with probabilities 𝑞! , 𝑞" and 1 − 𝑞! − 𝑞" for
Up, Middle and Down, respectively. In this case P2 earns, in expectation, 2𝑞! − 9(1 − 𝑞! −
𝑞" ) from choosing Left, 𝑞! + 3𝑞" from choosing Centre and 4𝑞" − (1 − 𝑞! − 𝑞" ) from
choosing Right. Are there values for these probabilities such that all three expected
payoffs are the same? The answer is no: 𝑞" = 1⁄2 equalizes the payoffs from Centre and
Right, and subsequently 𝑞! = 3⁄5 equalizes all three payoffs but then 𝑞! + 𝑞" > 1. Thus,
this doesn’t work either.
Hence, we are left with two mixed-strategy equilibria.

4. Consider the following symmetric, infinitely repeated, simultaneous-move game.

Player 2
Left Centre Right
Up 12, 12 –10, 27 –10, 0
Player 1 Middle 27, –10 5, 5 0, 𝑥
Down 0, –10 𝑥, 0 10, 10

Both players discount the future according to the discount factor 𝛿 = 3⁄5. Choose 𝑥 such that
the Up-Left cell can be sustained under a suitable trigger strategy.

Both players have of course an incentive to deviate from Up-Left because of the enticing 27.
We require the trigger strategy to be based on a credible punishment, i.e., to be based on a
Nash equilibrium of the stage game. Thus, let’s determine the stage-game equilibria first.

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Problem Set 6 - Solutions BE 510 Business Economics 1 - Autumn 2021

(a) If 𝑥 > 5 then Down-Right (with payoffs 10 and 10) is the only Nash equilibrium. This could
serve as a punishment. However, it turns out that it is simply not punishing enough to deter
players from grabbing the 27. To see this, consider the following comparison. A player who
cooperates under the trigger strategy obtains, in any given period, a present value of
12 12
𝑢# = = = 30
1 − 𝛿 2⁄5
while a player who defects by choosing Middle or Centre gets
10𝛿 10(3⁄5)
𝑢$ = 27 + = 27 + = 42 > 𝑢#
1−𝛿 2⁄5
(b) If 𝑥 ≤ 5 then Middle-Centre (payoffs 5 and 5) is also a Nash equilibrium. But even this is
not harsh enough to sustain Up-Left since
5𝛿 5(3⁄5)
𝑢$ = 27 + = 27 + = 34.5 > 𝑢#
1−𝛿 2⁄5
(c) A final possibility is a mixed-strategy Nash equilibrium. Up and Left cannot be involved in
that because they are strictly dominated by Middle and Centre, respectively. This leaves the
possibility of randomizing between Middle and Down [Centre and Right]. Expected payoffs
from these two pure strategies equalize if
10
5𝑝 = 𝑥𝑝 + 10(1 − 𝑝) ⟺ 𝑝 =
15 − 𝑥
The expected payoff in this MSE is 5𝑝 = 50⁄(15 − 𝑥) . This payoff increases in 𝑥 . Thus,
conversely, if 𝑥 is small enough this MSE may serve as a threat to deter non-cooperation. We
require
50 𝛿 50 3⁄5
𝑢$ = 27 + ≤ 30 = 𝑢# ⟺ 27 + ≤ 30 ⟺ 𝑥 ≤ −10.
15 − 𝑥 1 − 𝛿 15 − 𝑥 2⁄5