BE

510 Business Economics 1 - Autumn 2021

Problem Set 3

1. Apply the concept of iterated elimination of weakly dominated strategies on the following
game. (Find one solution.)
Column player
One Two Three Four Five Six Seven
Eins 17, 0 0, 2 19, −10 −6, 10 42, 9 8, 2 −10, −10
Zwei 20, 2 −12, 6 19, 6 0, 10 0, −1 0, 6 0, 2
Row player

Drei 0, −8 5, 2 19, 3 0, 0 −5, 2 3, 1 4, −6

Vier −1, 17 0, −6 8, −4 1, −4 −17, −8 −5, −6 1, 17
Fünf 0, 17 −5, −1 6, −4 −2, 10 5, −6 7, −1 4, 14
Sechs −5, 3 −12, 6 20, 8 −5, 0 −5, 6 0, 5 4, 4
Sieben 20, 4 2, −4 19, −4 −6, 10 42, −4 1, −4 0, 0

A (3,7)
2. Consider the two-player extensive-form game shown here.
2
Note: As usual, the first number in the (x,y) pairs at the end Up
of the game tree represents the payoff for player 1. B (7,6)

(a) Write down the reduced normal form.

1 a (1,0)
(b) Find all Nash equilibria and list all Pareto-efficient
A 1
outcomes. Are any of the equilibria Pareto-efficient?
Down b (2,7)
Are the equilibria Pareto-rankable?
2
Note: Two outcomes are Pareto-rankable if one of them is Pareto-
a (7,1)
superior to the other, that is, if it yields a higher payoff for at least
B
one player and no lower payoff for any other player. 1
(c) How do your results change when the dashed line is removed? b (5,6)
(d) Find the subgame-perfect equilibria for both the original game and the game without
the dashed line.

3. Reconsider the three-player game of PS 2. Find all pure-strategy subgame-perfect equilibria

when players 1 and 2 are moving simultaneously, but only after player 3 has made her move.

[A] Player 2 [B] Player 2

Left Right Left Right
Up 3 , 4 , 6 1 , 3 , 3 Up 2 , 2 , 4 4 , 1 ,5
Player 1 Middle 0 , 2 , 2 8 , 8 , 8 Player 1 Middle 3 , 1 , 4 1 , 0 , 4
Down 2 , 0 , 0 9 , 1 , 2 Down 1 , 3 , 3 6 , 1 , 0

Problem Set 3 - Solutions BE 510 Business Economics 1 - Autumn 2021

Problem Set 3 - Solutions

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

1. Apply the concept of iterated elimination of weakly dominated strategies on the following
game. (Find one solution.)
Column player
One Two Three Four Five Six Seven
Eins 17, 0 0, 2 19, −10 −6, 10 42, 9 8, 2 −10, −10
Zwei 20, 2 −12, 6 19, 6 0, 10 0, −1 0, 6 0, 2
Row player

Drei 0, −8 5, 2 19, 3 0, 0 −5, 2 3, 1 4, −6

Vier −1, 17 0, −6 8, −4 1, −4 −17, −8 −5, −6 1, 17
Fünf 0, 17 −5, −1 6, −4 −2, 10 5, −6 7, −1 4, 14
Sechs −5, 3 −12, 6 20, 8 −5, 0 −5, 6 0, 5 4, 4
Sieben 20, 4 2, −4 19, −4 −6, 10 42, −4 1, −4 0, 0

Step 1: “Six” is weakly dominated by “Two”, so we eliminate “Six”:

Column player
One Two Three Four Five Seven
Eins 17, 0 0, 2 19, −10 −6, 10 42, 9 −10, −10
Zwei 20, 2 −12, 6 19, 6 0, 10 0, −1 0, 2
Row player

Drei 0, −8 5, 2 19, 3 0, 0 −5, 2 4, −6

Vier −1, 17 0, −6 8, −4 1, −4 −17, −8 1, 17
Fünf 0, 17 −5, −1 6, −4 −2, 10 5, −6 4, 14
Sechs −5, 3 −12, 6 20, 8 −5, 0 −5, 6 4, 4
Sieben 20, 4 2, −4 19, −4 −6, 10 42, −4 0, 0

Step 2: “Eins” is now weakly dominated by “Sieben” and has to go:

Column player
One Two Three Four Five Seven
Zwei 20, 2 −12, 6 19, 6 0, 10 0, −1 0, 2
Drei 0, −8 5, 2 19, 3 0, 0 −5, 2 4, −6
Row player

Vier −1, 17 0, −6 8, −4 1, −4 −17, −8 1, 17

Fünf 0, 17 −5, −1 6, −4 −2, 10 5, −6 4, 14
Sechs −5, 3 −12, 6 20, 8 −5, 0 −5, 6 4, 4
Sieben 20, 4 2, −4 19, −4 −6, 10 42, −4 0, 0

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Problem Set 3 - Solutions BE 510 Business Economics 1 - Autumn 2021

Step 3: And now “Five” is weakly dominated by both “Two” and “Three”. Bye, bye, “Five”:

Column player
One Two Three Four Seven
Zwei 20, 2 −12, 6 19, 6 0, 10 0, 2
Drei 0, −8 5, 2 19, 3 0, 0 4, −6
Row player

Vier −1, 17 0, −6 8, −4 1, −4 1, 17
Fünf 0, 17 −5, −1 6, −4 −2, 10 4, 14
Sechs −5, 3 −12, 6 20, 8 −5, 0 4, 4
Sieben 20, 4 2, −4 19, −4 −6, 10 0, 0

Step 4: As a result of the departure of “Five”, “Fünf” becomes weakly dominated by “Drei”:

Column player
One Two Three Four Seven
Zwei 20, 2 −12, 6 19, 6 0, 10 0, 2
Row player

Drei 0, −8 5, 2 19, 3 0, 0 4, −6
Vier −1, 17 0, −6 8, −4 1, −4 1, 17
Sechs −5, 3 −12, 6 20, 8 −5, 0 4, 4
Sieben 20, 4 2, −4 19, −4 −6, 10 0, 0

Step 5: But this means the end for “Two” which is now weakly dominated by “Three”:

Column player
One Three Four Seven
Zwei 20, 2 19, 6 0, 10 0, 2
Row player

Drei 0, −8 19, 3 0, 0 4, −6
Vier −1, 17 8, −4 1, −4 1, 17
Sechs −5, 3 20, 8 −5, 0 4, 4
Sieben 20, 4 19, −4 −6, 10 0, 0

Step 6: “Sieben” is weakly dominated by “Zwei”:

Column player
One Three Four Seven
Zwei 20, 2 19, 6 0, 10 0, 2
Row player

Drei 0, −8 19, 3 0, 0 4, −6
Vier −1, 17 8, −4 1, −4 1, 17
Sechs −5, 3 20, 8 −5, 0 4, 4

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Problem Set 3 - Solutions BE 510 Business Economics 1 - Autumn 2021

Step 7: Thank you, “One”, but “Seven” is now weakly better:

Column player
Three Four Seven
Zwei 19, 6 0, 10 0, 2
Row player

Drei 19, 3 0, 0 4, −6
Vier 8, −4 1, −4 1, 17
Sechs 20, 8 −5, 0 4, 4

Step 8: “Zwei” can’t quite match the performance of “Drei”:

Column player
Three Four Seven
Drei 19, 3 0, 0 4, −6
RP Vier 8, −4 1, −4 1, 17
Sechs 20, 8 −5, 0 4, 4

Step 9: Now “Four” is weakly dominated by “Three”:

Column player
Three Seven
Drei 19, 3 4, −6
RP Vier 8, −4 1, 17
Sechs 20, 8 4, 4

Step 10: Here we get to a point where two strategies (“Drei” and “Vier”) are weakly dominated
by another one ( “Sechs”). You are now free to eliminate just one or both of them before you
turn to the Column Player once again. In the following I am considering all options.
(a) Eliminating just “Drei” does not create a The only way to proceed is to eliminate
dominance relationship between “Vier” as well. This leads to:
Column Player’s remaining strategies:
Column player
Column player Three Seven
Three Seven RP Sechs 20, 8 4, 4
Vier 8, −4 1, 17
RP
Sechs 20, 8 4, 4 Since “Seven” is weakly dominated by
“Three”, we are left with the strategy
pair (“Sechs”, “Three”) as our solution.

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Problem Set 3 - Solutions BE 510 Business Economics 1 - Autumn 2021

(b) Eliminating only “Vier” leads to: Hence:

Column player CP
Three Seven Three
Drei 19, 3 4, −6 Drei 19, 3
RP RP
Sechs 20, 8 4, 4 Sechs 20, 8

“Drei” could of course be eliminated as Since “Drei” is still dominated, we end

well now, but another alternative is to up with (“Sechs”, “Three”).
eliminate “Seven” since it is now
dominated by “Three”.

Thus, it turns out that the only solution via IEWDS is (“Sechs”, “Three”). Therefore, there
should be a Nash equilibrium at (“Sechs”, “Three”). Check that this is indeed the case.

2. Consider the two-player extensive-form game shown here. A (3,7)

Note: As usual, the first number in the (x,y) pairs at the end 2
of the game tree represents the payoff for player 1. Up (7,6)
B
(a) Write down the reduced normal form.
1 a (1,0)
While Player 2 can only choose A or B, she
makes this choice knowing whether Player 1 A 1
has chosen Up or Down. Thus, she can condition Down b (2,7)
her choice on what Player 1 has done before. Player 1 2
can choose between (i) Up, (ii) Down in combination with a, a (7,1)
B
or (iii) Down in combination with b. When choosing a or b he does 1
not know whether Player 2 has chosen A or B before. Hence, the reduced b (5,6)
normal form is:
Player 2
Always A Up: A, Down: B Up: B, Down: A Always B
Up 3 , 7 3 , 7 7 , 6 7 , 6
Player 1

Down + a 1 , 0 7 , 1 1 , 0 7 , 1
Down + b 2 , 7 5 , 6 2 , 7 5 , 6

(b) Find all Nash equilibria and list all Pareto-efficient outcomes. Are any of the equilibria
Pareto-efficient? Are the equilibria Pareto-rankable?
Note: Two outcomes are Pareto-rankable if one of them is Pareto-superior to the other, that is, if it
yields a higher payoff for at least one player and no lower payoff for any other player.
There are three pure-strategy Nash equilibria, which we find in the usual way. They are:
(1) Up / Always A. (2) Down + a / Up: A, Down: B. (3) Down + a / Always B.

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Problem Set 3 - Solutions BE 510 Business Economics 1 - Autumn 2021

All outcomes in the top row (‘Up’) are Pareto efficient (including the Up / Always A Nash
equilibrium). All other cells yield Pareto inefficient outcomes as they are Pareto inferior
to (3, 7) and/or (7, 6). Although only one of the Nash equilibria is Pareto efficient, the
outcome from this equilibrium is not Pareto superior to the other two.
(c) How do your results in (a) and (b) change when the dashed line is removed?
Removing the dashed line means that player 1, when choosing between a and b, now does
know what player 2 has chosen in response to his choice of Down in the first stage. Thus,
he can now condition his a/b choice on player 2’s move. The reduced normal form is now:
Player 2
Always A Up: A, Down: B Up: B, Down: A Always B
Up 3 , 7 3 , 7 7 , 6 7 , 6
Down + Always a 1 , 0 7 , 1 1 , 0 7 , 1
Player 1

Down + A: a, B: b 1 , 0 5 , 6 1 , 0 5 , 6
Down + A: b, B: a 2 , 7 7 , 1 2 , 7 7 , 1
Down + Always b 2 , 7 5 , 6 2 , 7 5 , 6

All results from (b) remain unchanged. There are no new pure-strategy Nash equilibria,
in which player 1 would condition his a/b choice or indeed in which he would ever choose
b. (Note that this does not imply that b is dominated by a in that subgame – it is not!)
The outcomes in the ‘Up’ row remain the only Pareto efficient ones.

(d) Find the subgame-perfect equilibria for both the original game and the game without the
dashed line.
Solve by backward induction. The game that has no dashed line is easier to solve:
• Subgame in the Up branch: Player 2 chooses A over B. Outcome: (3, 7).
• Subgame in the Down branch:
o A branch subgame: Player 1 chooses b over a. Outcome: (2, 7).
o B branch subgame: Player 1 chooses a over b. Outcome: (7, 1).
o Hence, player 2 goes for A (as 7 > 1). The outcome is (2, 7).
• Comparing outcome (3, 7) from Up with (2, 7) from Down player 1 goes for Up.
Result: The unique subgame perfect equilibrium is Up-b-a / Always A.
In the game with the dashed line we have to pay special attention to the subgame in the
Down branch. This is a simultaneous-move game with two Nash equilibria:
• Given that player 1 picks a, player 2’s best response is to pick B. Conversely, given that
player 2 does pick B, player 1’s best response is to indeed pick a. Outcome: (7, 1).
• Given that player 1 picks b, player 2’s best response is to pick A. Conversely, given that
player 2 does pick A, player 1’s best response is to indeed pick b. Outcome: (2, 7).

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Problem Set 3 - Solutions BE 510 Business Economics 1 - Autumn 2021

As before, choosing Up will cause player 2 to choose A implying an outcome of (3, 7).
Given the presence of the second Nash equilibrium in the Down branch (2, 7), Up is a best
response under subgame perfection. Alternatively, the first Nash equilibrium in the Down
branch is played (7, 1), yielding a better outcome for player 1 than choosing Up.
Result: We have two subgame perfect equilibria in this game. They are:
• Up + b / Always A
• Down + a / Up: A, Down: B

3. Reconsider the three-player game of PS 2. Find all pure-strategy subgame-perfect equilibria

when players 1 and 2 are moving simultaneously, but only after player 3 has made her move.

[A] Player 2 [B] Player 2

Left Right Left Right
Up 3 , 4 , 6 1 , 3 , 3 Up 2 , 2 , 4 4 , 1 ,5
Player 1 Middle 0 , 2 , 2 8 , 8 , 8 Player 1 Middle 3 , 1 , 4 1 , 0 , 4
Down 2 , 0 , 0 9 , 1 , 2 Down 1 , 3 , 3 6 , 1 , 0

If player 3 chooses [A], players 1 and 2 enter a subgame with two Nash equilibria, namely {Up,
Left} and {Down, Right}. In a subgame-perfect Nash equilibrium (SPE) it is required that they
play one of these. Hence, player 3 obtains either a payoff of 6 or a payoff of 2. If player 3
chooses [B] players 1 and 2 play {Middle, Left} and player 3 obtains a payoff of 4.
Since 4 is more than 2 but less than 6, there are two SPEs. In the first one player 1’s strategy
is {A:Up, B:Middle}, player 2’s strategy is {A:Left, B:Left} and player 3’s strategy is [A]. Player
3 obtains a payoff of 6.
In the second SPE player 1’s strategy is {A:Down, B:Middle}, player 2’s strategy is {A:Right,
B:Left} and player 3’s strategy is [B]. Player 3 obtains a payoff of 4.
The case where player 3 chooses [A] and player 1 and player 2 play {Down, Right} is not a SPE
because given that they do this and given that they play the equilibrium in subgame B, player
3 is not best responding by choosing [A].