LONDON SCHOOL OF ECONOMICS Leonardo Felli

Department of Economics 32L.4.02; x7525

Solutions to Assignment 10
EC487 Advanced Microeconomics Part I

1. The unique mixed strategy Nash equilibrium of game A is (D, D) with payoff
(0, 0).
The three mixed strategy Nash equilibria of game B are (S, S) and (B, B)
both with payoff (4, 4), and then 21 , 21 with expected payoff (2, 2).

The Subgame perfect equilibrium strategies for the dynamic game are:

• Play D in period 1.
• If in period 1 the outcome of the game is (D, D) then play S in period
2.
• If in period 1 the outcome of the game is different from (D, D) then
1
each player randomize with probability 2
on S and B in the second
period.

Notice that it is subgame perfect to punish deviations in period 2 since

1 1


,
2 2
is a Nash equilibrium of the period 2 subgame. Moreover the
strategies above are Subgame Perfect if and only if:

1−δ 1−δ
2 (4 + δ 4) ≥ (5 + δ 2)
1−δ 1 − δ2

or
1
δ≥ .
2
This Subgame Perfect equilibrium is such that the average discounted
payoff to each player is:

1−δ
(4 + δ 4) = 4.
1 − δ2

1
2. Consider first the stage games A and B.

(i) The unique mixed strategy Nash equilibrium of game A is (D, L)

with payoff ( 37 , 73 ).
The three mixed strategy Nash equilibria of game B are (S, S) with
payoff (2, 4), (B, B) with payoff (4, 2), and the non-degenerate mixed
strategy Nash equilibrium 31 , 23 with expected payoff (4/3, 4/3).

(ii) The Subgame perfect equilibrium strategies for the dynamic game
that supports the players’ average discounted payoffs (2, 4) are de-
fined as follows.
Player 1’s strategies are:
– Play U in period 1.
– If in period 1 the outcome of the game is (U, L) play S in period
2.
– If in period 1 the outcome of the game is different from (U, L)
then in period 2 play the mixed strategy Nash equilibrium of
1
game B where player 1 randomizes with probability 3
on action
S.
Player 2’s strategies are:
– Play L in period 1.
– If in period 1 the outcome of the game is (U, L) play S in period
2.
– If in period 1 the outcome of the game is different from (U, L)
then in period 2 play the mixed strategy Nash equilibrium of
2
game B where player 2 randomizes with probability 3
on action
S.
Notice that it is subgame perfect to punish deviations in period 2
since 13 , 23 is a mixed strategy Nash equilibrium of game B. More-

over the strategies above are Subgame Perfect for player 1 if and
only if:  
1−δ 7 4
2≥ +δ
1 − δ2 3 3

2
 or
1
δ≥ . (1)
2
Notice that the strategies above are Subgame Perfect for player 2
whatever his discount factor δ:
 
1−δ 7 4
4> +δ
1 − δ2 3 3

This Subgame Perfect equilibrium is such that the expected average

discounted payoff to player 1 is:

1−δ
(2 + δ 2) = 2
1 − δ2

while to player 2 is:

1−δ
(4 + δ 4) = 4.
1 − δ2
(iii) The Subgame perfect equilibrium strategies for the dynamic game
that supports the players’ average discounted payoffs (4, 2) are de-
fined as follows.
Player 1’s strategies are:
– Play D in period 1.
– If in period 1 the outcome of the game is (D, R) play B in period
2.
– If in period 1 the outcome of the game is different from (D, R)
then in period 2 play the mixed strategy Nash equilibrium of
1
game B where player 1 randomizes with probability 3
on action
S.
Player 2’s strategies are:
– Play R in period 1.
– If in period 1 the outcome of the game is (D, R) play B in period
2.
– If in period 1 the outcome of the game is different from (D, R)
then in period 2 play the mixed strategy Nash equilibrium of

3
 2
game B where player 2 randomizes with probability 3
on action
S.
Once again it is subgame perfect to punish deviations in period 2
since 31 , 23 is a mixed strategy Nash equilibrium of game B.

The strategies above are Subgame Perfect for player 1 whatever the
discount factor δ  
1−δ 7 4
4> +δ
1 − δ2 3 3
while the strategies above are Subgame Perfect for player 2 if and
only if:  
1−δ 7 4
2≥ +δ
1 − δ2 3 3
or
1
δ≥ . (2)
2
This Subgame Perfect equilibrium is such that the expected average
discounted payoff to player 1 is:

1−δ
(4 + δ 4) = 4
1 − δ2

while to player 2 is:

1−δ
(2 + δ 2) = 2.
1 − δ2
(iv) The lowest discount factor that supports the strategies in (ii) and (iii)
above is
1
δ= (3)
2

3. Sketch of the answers.

(i) The unique Nash equilibrium of the stage game Γ1 is (D, D) yielding
payoff (3, 3).

(ii) The minmax payoff π i of each player is π i = 3, i ∈ {1, 2}, and corre-
sponds to the strategy D played by both players.

4
(iii) The unique Subgame perfect equilibrium of the two period finite hori-
zon can be described as follows.

• Play D in the first period of the game.

• Play D in the second period of the game regardless of the history of
play.

The proof is by backward induction.

5
4. Consider now the stage game Γ2 .

(i) There exists two SPE of the stage game Γ2 . They are characterized
by the following strategies and parameterized by the identity of the row
player i ∈ {1, 2}.

• Player C chooses player Ri in the first phase of Γ2 .

• Both C and Ri choose D in the second phase of Γ2 .

These strategies yield payoff 3 to both C and Ri and payoff 0 to the re-
maining row player R−i .
The proof is again by backward induction.

(ii) The minmax payoffs π Rh of player Rh , h ∈ {1, 2}, is π Rh = 0 and

corresponds to the strategy ”choose row player Ri , i 6= h in the first
phase and choose any action in the second phase of Γ2 ” for player C
and to the strategy ”choose any action in the second phase of Γ2 ” for
player Rk , k ∈ {1, 2}.

(iii) It is possible to construct a SPE of the two period repeated game that
supports a payoff of 7 for C a payoff of 1 for Ri and a payoff of 0 for R−i .
The following strategies represent such a SPE.

• In the first phase of period one player C chooses Ri . In the second

phase of period one C chooses action D while Ri chooses action C.
• If the history of play in the first period is (C, D) then in the first phase
of the second period C chooses Ri . In the second phase of period
two both C and Ri choose action D.
• If the history of play in the first period differs from (C, D) then C
chooses player R−i in the first phase of period two. In the second
phase of period two both C and R−i choose action D.

Notice that it is subgame perfect to punish deviations by Ri in period

two since there exists an SPE of the stage Game Γ2 where player Ri is
not selected in the first phase of the second period (question (iv) above).

6
 Moreover the strategies above are Subgame Perfect for player Ri if and
only if:
(1 + δ 3) ≥ 3.

This is satisfied for every δ ≥ 2/3.

5. The set of feasible payoffs is the convex hull of (0, 0), (1, 2) and (2, 1). This
is the set
{(v1 , v2 ) | v1 ≤ 2v2 , v2 ≤ 2v1 , and v1 + v2 ≤ 3}

The highest symmetric payoff is 23 , 32 as the sum of the parties’ payoffs

is lower or equal to 3 in each stage game.

9
For δ = 10
we get an equilibrium with this payoff by having the players
usually alternate between (2, 1) and (1, 2), but with each equilibrium oc-
casionally played twice in a row to even things out.
Play (S, S) in period 0 and play (B, B) in period 2. If after k periods
the strategies have been followed and the resulting average discounted
payoffs to date are (v1 , v2 ): play (S, S) in period k + 1 if v1 ≤ v2 , or play
(B, B) in period k + 1 if v1 > v2 . If player i deviates from the strategy
in period t, play the mixed minmax equilibrium strategies (with payoffs
2 2


, ) in all future periods.
3 3

Notice that the average payoffs oscillate around the point 32 , 32 infinitely


3
often because whenever player i’s payoff is above 2
it is at most two
3 9
periods before it decreases below (Using δ ≥ 10
2
. we can verify that
(S, S), (B, B), (B, B) has average payoff lower than 32 for player 1.)
The average payoff of player 1, as well as the payoff of player 2, converge.
Hence, they must converge to 32 , 23 . No player will deviate as he loses

utility in both the current and in all future periods.

6. The set of feasible payoffs is the convex hull of (−1, −1), (5, 0), (4, 4) and
(5, 0) let this set be denoted V . The minmax payoffs of both players are

7
π i = 0. Hence, the set of feasible and individual rational payoffs V is

V = V ∩ {(v1 , v2 )|vi ≥ 0, i = 1, 2}