Institut für Controlling

Prof. Dr. Jens Robert Schöndube

Dr. Sandra Katarina Kronenberger
M.Sc. Jana Holze

Decision Theory / Analytical Accounting

Winter Term 2019 / 2020

Problem Set 2

Exercise 2.1: (Iterated Elimination of Strictly Dominated Strategies)

Consider the following pay-off matrix.

d e f g
a 4,1 0,0 3,4 1.5 , 2
b 1,1 -1 , 2 2,1 0.5 , 1.5
c 0,2 2,4 4,1 3 , 2.5

Find and eliminate all strictly dominated strategies. Can we find an equilibrium through iterated strict
dominance?

Exercise 2.2: (Nash-Equilibrium in Pure and Mixed Strategies)

Jim is a taxpayer and is currently considering two alternatives: If he is honest, he will pay taxes of 2
and if he cheats on his tax report, he will not pay any taxes. The tax office can either trust Jim or
check his tax return, which leads to audit costs of 1. If Jim decides to cheat, auditing will reveal this
and consequently he will have to pay a fine of 2, in addition to his tax payment.

a) Present the game in a normal form.

b) Does an equilibrium in pure strategies exist? Determine all Nash equilibria of the game.

Decision Theory / Analytical Accounting - Problem Set 2 - Page 1/4

Exercise 2.3: (Static Game of Complete Information – Cournot Model)
The two companies MaxTech (M) and LowTech (L) are competing in quantities and offer
electronic devices.
The goal of each company is to maximize its profits. The profit is calculated in the usual way,
revenues minus costs, and the market price depends on the total quantity produced 𝑃 𝑄 200
𝑄. 𝑄 characterizes the aggregate quantity on the market and 𝑃 is the market clearing price. The
constant marginal cost of production for the company MaxTech are 14€ and for the company
LowTech are 20€.

a) What do the objective functions of the two companies look like?

b) Determine the reaction functions and plot them.
c) Determine the equilibrium quantities.
d) Determine the equilibrium prices and profits.

Exercise 2.4: (Static Game of Complete Information – Bertrand Model)

Two companies, 𝑖 𝐴, 𝐵, are competing in prices and offer heterogeneous goods, which are
substitutes. The demand function of production is:

1
9 3𝑝 𝑝 𝑓𝑜𝑟 𝑝 3 𝑝
𝑞 𝑞 𝑝 ,𝑝 3
1
0 𝑓𝑜𝑟 𝑝 3 𝑝
3

The costs of production are 𝐶 2𝑞 . The companies are setting prices simultaneously.

a) Does a pure strategy equilibrium exist? (Use the Nikaido-Isoda Theorem!)

b) Do the price strategies constitute strategic complements or strategic substitutes?
c) Determine the reaction functions and plot them.
d) Determine the equilibrium prices, quantities and profits.
e) Which equilibrium prices, quantities and profits would result from a quantity competition?
Compare the results to the results from part d).

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Exercise 2.5: (Bayesian Game and Bayesian Nash Equilibrium)
Two weeks ago, Anna and Brian arranged a date for tonight. In the meantime, both of them forgot
whether they wanted to go to the Rock concert or to the Hard Rock Cafe. Anna is doubtful if Brian
wants to go out with her or if he is trying to avoid her. Brian in turn feels certain that Anna wants to
go out with him. Due to Anna s negative experience with men, she estimates a 50 percent
probability that Brian wishes to go out with her. Consequently, with a probability of 50 percent she
guesses that Brian is avoiding her. The following utility values arise from having a date (which is
going to the concert or having a drink in the cafe) in case Brian wishes to go out with Anna:

Anna
Concert Cafe

Concert 1 0
Brian 2 0
Cafe 0 2
0 1

If Brian is trying to avoid Anna, then this leads to the following utility values:

Anna
Concert Cafe

Concert 0 1
Brian 2 0
Cafe 2 0
0 1

a) Represent the game in Harsanyi s Bayesian representation as well as in a strategic form.

b) Determine the Bayesian (Nash-) equilibrium in pure strategies.
c) After having a phone call with Brian, Anna estimates the probability that Brian wishes to go
out with her at 75 percent. Which strategies constitute a Bayesian equilibrium now?

Decision Theory / Analytical Accounting - Problem Set 2 - Page 3/4

Exercise 2.6: (Static Game of Incomplete Information – Bertrand Model)
Two companies 𝑖 1,2 are competing in prices and offer heterogeneous goods. The demand
functions of the companies are given by:

12 𝛾𝑝
12 4𝑝 𝛾𝑝 𝑓𝑜𝑟 𝑝
𝑞 𝑞 𝑝 ,𝑝 4
12 𝛾𝑝
0 𝑓𝑜𝑟 𝑝
4

The costs of production are 𝐶 𝑞 . Neither company knows with certainty how their own price
1
affects the demand of the other company. It is just known that 𝑃𝑟 𝛾 1|𝛾 and
2
1
𝑃𝑟 𝛾 3|𝛾 2
for 𝛾 1, 3 and 𝑖 𝑗 1,2 .

a) Determine the reaction functions of both companies.

b) What are the equilibrium prices of the companies?
c) What are the equilibrium quantities and profits?

Exercise 2.7: (Static Game of Incomplete Information – Cournot Model)

Two companies 𝑖 1,2 are competing in quantities and offer homogeneous goods. The inverse
demand functions are given by:
15 4𝑞
15 2𝑞 4𝑞 𝑓𝑜𝑟 𝑞
𝑝 𝑝 𝑞 ,𝑞 2
15 4𝑞
0 𝑓𝑜𝑟 𝑞
2
The costs of production are 𝐶 𝑐 𝑞 for 𝑐 𝐿, 𝐻 . Neither company knows with certainty whether
the quantity of the other company is influenced by high or low costs. They just know that
1 2
𝑃𝑟 𝑐 2 3
and 𝑃𝑟 𝑐 𝐻 4 3
for 𝑐 2, 4 .

a) Determine the reaction functions of both companies.

b) What are the equilibrium quantities of the companies?
c) What are the equilibrium prices and profits of the companies?

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