GT Homework 2 PDF

Case Western Reserve University
Department of Economics
ECON 329 - Game Theory
Spring 2015
Homework #2
Lectures 5, 6 & 7
Return in Class on Thursday Feb 12th
Name:
Total points ____ out of 20.

1. Cournot Model of duopoly where firms have asymmetric cost functions (8 points). A product is
produced by only two firms: firm 1 and firm 2. The quantity produced by firm 1 is denoted as 1 and the
quantity produced by firm 2 is denoted as 2 . Each firm chooses the quantity (any positive number) without
knowing the other firms choice. The payoff of each firm depends on the market price and the cost of
production . The market price is determined by the following formula: () = , where is a constant
number and = 1 + 2 is the aggregate quantity produced on the market by both firms. The cost of producing
1 to firm 1 is 1 (1 ) = 1 1 and the cost of producing 2 to firm 2 is 2 (2 ) = 2 2 . (Note: the difference
between this problem and the problem considered in the class is that in the class we assumed that firms are
homogeneous and so they have the same marginal costs 1 = 2 = , while here we assume that 1 > 2 ).
a) Write down the normal form representation of this game (2 points).
b) Find the best response functions of firm 1 and firm 2 (2 points).
c) Find the Nash equilibrium quantities 1 and 2 of this game by simultaneously solving the two best responses
obtained in part (b) (2 points).
d) Show that when 1 > 2 then 1 < 2 , i.e. at the equilibrium firm 1 with a higher marginal cost 1 produces
less than firm 2 with a lower marginal cost 2 (Hint: simply subtract 1 from 2 and show that this difference is
positive) (2 points).
2. Contest where players are asymmetric (8 points). Two players participate in a contest: player 1 and player
2. Both players decide how much effort to spend (any positive number) in order to win the contest. The effort
1
expenditures are denoted by 1 and 2 . The player 1s probability of winning the contest is 1 (1 , 2 ) = +
2
and the player 2s probability of winning the contest is 2 (1 , 2 ) =
1 +2
. The player who wins the contest
receives a prize . Regardless of who wins the contest both players have to pay their effort expenditures. The
cost to player of expending effort is ( ) = . (Note: the difference between this problem and the
problem considered in the class is that in the class we assumed that both players affect the probabilities of
winning in the same way (1 , 2 ) = +

, while here player 1 is times more skilled than player 2 and thus
1
he has a greater effect on the probability of winning 1 (1 , 2 ) =
1 +2
).
a) Write down the normal form representation of this game (2 points).
b) Find the best response functions of player 1 and player 2 (2 points).
c) Find the Nash equilibrium efforts 1 and 2 of this game using the FOCs (2points).
d) Calculate the equilibrium effort of player 2 when = 1 and = 100. Then calculate the equilibrium effort
of player 2 when = 4 and = 100. (Note: = 1 means that players have the same abilities, while = 4
means that one player is a superstar). Provide intuition as to why these efforts are different. (2 points).
3. Behavior in contests (4 points). In the class contest experiment, we observed that the actual efforts in the
contest are significantly higher than predicted by Nash equilibrium (30-50% higher).
a) Provide five different explanations for overbidding in contests (1 point). Hint: you can find many
explanations in the article Overbidding and Heterogeneous Behavior in Contest Experiments which was
published in the Journal of Economic Surveys http://onlinelibrary.wiley.com/doi/10.1111/joes.12022/abstract. If
you are off campus, you may not have a direct access to the journal, so here is the link to an open access
version: http://ideas.repec.org/p/chu/wpaper/13-06.html.
b) How would you incorporate the utility of winning into a standard contest model (1 point). Hint: you can find
a formal model of the utility of winning in a recent book chapter Behavioral Dimensions of Contests which is
publicly available at https://ideas.repec.org/p/chu/wpaper/14-14.html.
c) How would you incorporate the relative payoff maximization (inequality aversion) into a standard contest
model (1 point). Hint: you can find a formal model of the relative payoff maximization in a recent book chapter
Behavioral Dimensions of Contests which is publicly available at https://ideas.repec.org/p/chu/wpaper/1414.html.
d) How would you re-design the classroom contest experiment to reduce overbidding in contests (1 point).
Hint: you can find some solutions in the article Overbidding and Overspreading in Rent-Seeking Experiments:
Cost Structure and Prize Allocation Rules which was published in Games and Economic Behavior
http://www.sciencedirect.com/science/article/pii/S0899825614000839. If you are off campus, you may not have
a direct access to the journal, so here is the link to an open access version:
https://ideas.repec.org/p/chu/wpaper/14-08.html.

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Case Western Reserve University

Total points ____ out of 20.

b) Find the best response functions of firm 1 and firm 2 (2 points).

and the player 2s probability of winning the contest is 2 (1 , 2 ) =

. The player who wins the contest

winning in the same way (1 , 2 ) = +

he has a greater effect on the probability of winning 1 (1 , 2 ) =

a) Write down the normal form representation of this game (2 points).

b) Find the best response functions of player 1 and player 2 (2 points).

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