Problemset #11

Exercise 5.b: Find the pooling pure strategy perfect BNE.

A pooling equlibrium: Both types of workers give the same signals. Both the high- and low-type
choose an education level e p. Therefore, the firm cannot see the difference from the two.

Using the cookbook:

(1) Applying Bayes rule
μ ( e |θH ) ∙ μ ( θ H )
p
1 ∙ pH
μ ( θ H|e )=
p
= = p H This gives the:
μ ( e |θ H ) ∙ μ ( θ H ) + μ ( e |θ L ) ∙ μ ( θ L ) μ ( e |θ H ) ∙ μ ( θ H )+ 1∙ ( 1− p H )
p p p

μ ( θ H|e )=
{ p H if e=e p
0 if e ≠ e
p
μ ( θ H|e )=
{
1− p H if e=e p (2) Signaling requirement 2 for receiver:
1 if e ≠ e
p

{ 3 ∙ μ ( θ H|e ) +1∙ μ ( θ L|e ) if e=e

p p p
w ( e )= Where
3 ∙ μ ( θ H|e ≠ e ) +1∙ μ ( θ L|e ≠ e ) if e=e
p p p

{
p
w ( e )= 3 p H +1 ∙ ( 1− p H ) if e=e
p
, the result is:
3∙ 0+1 ∙1 if e=e

{
p
w ( e )= 1+2 p H if e=e p (3)
1if e=e
p
e
L: w ( e P )−c θ ( e p )=1+2 p H −
1
L

The condition:
p p
e e 0 p
1+2 p − ≥ w ( 0 ) −c θ ( 0)1+2 p − ≥ 1− e ≤ 2 p H w ( e ) −c θ ( e ) ≥ w (0)−c θ (0)
H H p p

1 L
1 1 H H

p
e 0 p p
1+2 p H − ≥ 1− e ≤ 6 p H The constraint e ≤ 2 p H is more binding than this one. The PBE:
3 3
PBE=( e H =e L=e P ∈ [ 0,2 p H ] , w p ( e )|μ p ( θ|e ) )
Problemset #12
Exercise 1:
Consider figure 4.2.8. in Gibbons (p.201). Remind yourselves about the separating equilibrium
¿
related to the figure. Why can the high type not choose e (H ) in a separating equilibrium?
 ¿
If there is a belief that the worker is high-ability if e ≥ e (H ) and low-ability otherwise.
¿
Since e ( H ) is the high-ability worker's best response to the wage function w= y ( H , e) , it is also
¿
the best response here. As for the low-ability worker, e (L) is that worker's best response when
¿
the wage function is w= y (L , e), so w (L)−c ¿ is the highest payoff that worker can achieve here
among all choices of e <e ¿ ¿).

Since the low-ability worker's indifference curves are steeper than those of the high-ability worker,
w ¿ ( H )−c[ L , e¿ (H)] is the highest payoff the low-ability worker can achieve here among all
¿
choices of e >e ¿ ¿). Thus, e*(L) is the low-ability worker's best response because w (L)−c ¿)} in the
no-envy case.

We hereafter ignore the no-envy case. As suggested previously, Figure 4.2.6 (the envy case) is
more interesting. Now the high-ability worker cannot earn the high wage w(e) = y(H, e) simply by
choosing the education e*(H) that he or she would choose under complete information. Instead,
¿
to signal his or her ability the high-ability worker must choose e s >e ( H ), as shown in Figure 4.2.8,
because the low-ability worker will mimic any value of e between e*(H) and e s if doing so tricks the
firms into believing that the worker has high ability.

Exercise 2:

Exercise 3: Consider the games (a)-(d) on the next page. Which of these are cheap-talk games?
For those which are cheap-talk games, find a separating equilibrium if such an equilibrium
exists, or show that no separating equilibrium exists.
Cheap talk: A CT-message is a costless message. It is costless for the sender to send the message
(it does not affect his payoffs) & it is costless to receive the message. Therefore, the payoffs are
independent from the message.

There is symmetry in (a) and (d). Payoffs for both type 1 and 2 the payoffs for the receiver and
 sender are the same.
(a) Seperating equilibrium LR:

The beliefs: p=1 and q=0 .

The best response to L is up and the best response to R is down.
t 1: no incentive to deviate if a ≤ 3
t 2: No incentive to deviate as 5 is larger than 2.
Therefore:
PBE=(LR ,ud , p=1 , q=0 , a≤ 3)(a) Seperating equilibrium: RL

The beliefs: p=0 and q=1

The best response to L is down and to R it is u.
t 1: No incentive to deviate if a ≤ 3
t 2: No as 2 are smaller than 5.
It is exactly the opposite as before.
Therefore:
PBE=( RL , du , p=0 , q=1 , a ≤ 3 )
 (d): Seperating equilibrium: LR

Beliefs: p=1 and q=0

The best response for L is up and the best reponse to R is also up.
t 1: No incentive to deviate because the payoff is the same if he deviates and chooses R.
t 2: No incentive to deviate because the payoff is the same if he deviates and chooses L.
Therefore:
PBE=(LR ,UU , p=1 ,q=0) PBE=(RL ,uu , p=0 , q=1).

Exercise 4:
High qualified Medium qualified Low qualified
High ability 3,3 0,0 0,0
Medium ability 1,0 2,2 0,0
Low ability 1,0 2,0 0,1
Right entry - firm. Left - applicant.

(a) Show that no fully seperating PBE exists, where each type of applicant sends a different
message. What is the intuition behind this result?
(1) Fully separate PBE, send a truthful message?
1
1∙
μ r ( m=H|t=H ) μ r ( t=H ) 3
μr ( t=H∨m=H )= =
μr ( m=H|t=H ) μr ( t=H ) + μr ( m=L|t=M ) μ r ( t=M ) + μ r ( m=H|t=L ) μr ( t=L ) 1 1 1
1∙ +0 ∙ +0 ∙
3 3 3
So:

{ {
1 if t =t H 0 if t =t H
μ ( t|m=H )= 0 if t =t μ ( t|m=M )= 1 if t =t (2)
M M
0if t =t L 0 if t =t L
Eu ( a=H q ∨m=H )=3∗μr ( t =H|m=H )+ 0∗μ r ( t=M |m=H )+ 0∗μ r ( t= L|m=H )=3∗1+0∗0+0∗0=3
Eu ( a=M q|m=H ) =0∗1+2∗0+ 0∗0=0
Eu ( a=Lq|m=H ) =0∗1+0∗0+1∗0=0 Eu ( a=H q ∨m=M )=3∗0+ 0∗1+0∗0=0
Eu ( a=M q|m=M ) =0∗0+2∗1+ 0∗0=2
 Eu ( a=Lq|m=M ) =0∗0+0∗1+1∗0=0

Eu ( a=H q ∨m=L )=3∗0+ 0∗0+ 0∗1=0

Eu ( a=M q|m=L ) =0∗0+2∗0+0∗1=0
Eu ( a=Lq|m=L ) =0∗0+0∗0+1∗1=1

(3)
H: No incentive to deviate for worker if the person is high-ability since the payoff is zero otherwise.

M: No incentive to deviate since 1 and 0 is lower than 2.

L: Incentive to get a medium qualified job while true ability is low. Therefore, incentive to deviate.

No PBE.

(b) Show that a partial pooling PBE does exist, where the high-ability applicant sends the
message m=H and the other two types send the message m=M . What are the firm’s beliefs
about the applicant if he receives the message m=H or m=M (on the equilibrium path), or if he
receives the message m=L (off the equilibrium path)? In each case, solve for the firm’ optimal
action given its belief.
High type sends a m=H and the medium- and low-type sends m=M .
If a high-type message is send, the worker will be a high-type with certainty:

{
1 if t=t H
μ ( t|m=H )= 0 if t=t M If there is send a medium-type message the worker could be both a medium
0if t=t L
and low-type:

{
0if t=t H
1
μ ( t|m=M )= 2 if t=t M Is a low-type message is send, the worker will definitely be a low-type.
1
if t=t L
2
Otherwise a medium message would have been send because there is no incentive to send a low
message if he is a medium type (see matrix):

{
0 if t=t H
( | )
μ t m=L = 0 if t=t M (2)
1if t=t L
Eu ( a=H q ∨m=H )=3∗μr ( t =H|m=H )+ 0∗μ r ( t=M |m=H )+ 0∗μ r ( t= L|m=H )=3∗1+0∗0+0∗0=3
Eu ( a=M q|m=H ) =0∗1+2∗0+ 0∗0=0
0∗1 0∗1
Eu ( a=Lq|m=H ) =0∗1+0∗0+1∗0=0 Eu ( a=H q ∨m=M )=3∗0+ + =0
2 2
2∗1 0∗1
Eu ( a=M q|m=M ) =0∗0+ + =1
2 2
 0∗1 1∗1 1
Eu ( a=Lq|m=M ) =0∗0+ + =
2 2 2

Eu ( a=H q ∨m=L )=3∗0+ 0∗0+ 0∗1=0

Eu ( a=M q|m=L ) =0∗0+2∗0+0∗1=0
Eu ( a=Lq|m=L ) =0∗0+0∗0+1∗1=1

(3)
H: No incentive to deviate for worker if the person is high-ability since the payoff is zero otherwise.

M: No incentive to deviate since 1 and 0 is lower than 2.

L: Low type will send m=M and true type is L. That gives the payoff 2. Otherwise, the payoff is 1.
Therefore, no incentive to deviate.

=> PBE!
PBE=( H −M −M , H q −M q−Lq|μ ( t |m ) ) m=H ? If so, describe the players’ equilibrium strategies
and beliefs, and discuss whether this pooling PBE looks more or less reasonable than the partial
pooling PBE from (b).

H, M and L send m=H .

{
1
if t=t H
3
μ ( t|m=H )= 1 if t=t M If someone doesn’t stick to the strategy, we assume that he is a low-type
3
1
if t =t L
3
worker:

{ {
0 if t =t H 0 if t =t H
( | ) ( |
μ t m=M = 0if t =t M μ t m=L = 0 if t =t M (2)
)
1 if t =t L 1if t=t L
3∗1 0∗1 0∗1
Eu ( a=H q ∨m=H )=3∗μr ( t=H|m=H )+ 0∗μ r ( t=M |m=H )+ 0∗μ r ( t= L|m=H )= + + =1
3 3 3
0∗1 2∗1 0∗1 2 0∗1 0∗1 1∗1 1 Best response for
Eu ( a=M q|m=H ) = + + = Eu ( a=Lq|m=H ) = + + =
3 3 3 3 3 3 3 3
H type is to message H type.

Eu ( a=H q ∨m=M )=3∗0+0∗0+ 0∗1=0

Eu ( a=M q|m=M ) =0∗0+2∗0+0∗1=0
Eu ( a=Lq|m=M ) =0∗0+0∗0+1∗1=1
Best reponse for M type is to message L type.
 Eu ( a=H q ∨m=L )=3∗0+ 0∗0+ 0∗1=0
Eu ( a=M q|m=L ) =0∗0+2∗0+0∗1=0
Eu ( a=Lq|m=L ) =0∗0+0∗0+1∗1=1
Best response for L type is to message L type.

(3)
H: No incentive to deviate (see matrix) as 0 is smaller than 3.
M: No incentive to deviate as 1 > 0.
L: Payoff is 1. Sends medium or low message gives low qualified job. Gives payoff 1. Not strictly
larger. Therefore, no incentive to deviate.

=> PBE=( H −H−H , H q−Lq −Lq|μ ( t|m) )