Solution Manual for Intermediate Microeconomics and

Its Application 12th Edition Nicholson Snyder

1133189024 9781133189022
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CHAPTER 5
Game Theory
A. Summary
This chapter provides an introduction to game theory, providing students with
tools to analyze simple games.
We have placed this chapter so early in the text for several reasons. Of
course it is useful to have this material covered before it is used in later
chapters, most importantly in studying the strategic interaction between
oligopoly firms in Chapter 12. But placing it up front in the text in Part 3 on
uncertainty and strategy drives home the point that game theory is not just for
oligopolies. We view game theory as the natural generalization of the
maximizing decision maker (the foundation of our analysis of consumer and
producer theory) to settings with two or more decision makers whose decisions
interact. Game theory applies to the interactions ranging from that between
individual people (say neighbors regarding how they maintain their yards) to
that between nations (say countries deciding whether or not to sign a new
climate treaty).
The chapter begins with a description of the components of a game:
players, strategies, and payoffs. Then it turns to the fundamental equilibrium
concept for simultaneous games, Nash equilibrium. Then it turns to sequential
games and the equilibrium concept for these, subgame-perfect equilibrium. It
ends with more advanced topics including repeated games, games with
continuous actions, and so forth. The focus throughout is on methods to solve
for equilibrium.
The chapter deals mostly with classic, abstract games such as the
Prisoners’ Dilemma and the Battle of the Sexes. As mentioned above,
applications of game theory to analyze imperfect competition have been
moved forward to Chapter 12.

1
2 Chapter 5: Game Theory

We only briefly touch on games of asymmetric information, games in

which one player has better information about the world than another. Such
games are more complex than those studied in the chapter. A whole later
chapter, Chapter 15, is devoted to the study of games of asymmetric
information.

B. Lecture and Discussion Suggestions

The various game theory concepts introduced in this chapter are, we believe,
best illustrated with specific games in lecture. Three simple ones to begin with
might be the Prisoner’s Dilemma, Matching Pennies, and the Battle of the
Sexes. The various concepts can be introduced one after the other in analyzing
these simple games, as demonstrated in the text.
One way to inject fun into the lecture is to have students play games in
class. Avinash Dixit, “Restoring Fun to Game Theory,” Journal of Economic
Education 36: 205-219 (Summer 2005) provides a handful of tested classroom
experiments that are both entertaining and illustrative of important concepts.
He advises using monetary payoffs and advises providing a brief discussion
immediately after the game of the theoretical points raised.
Students often raise the issue that the equilibrium predictions in, for
example, the Prisoners’ Dilemma and the Battle of the Sexes are off target
because of dynamic aspects of the game, possibilities of threats and other
communications, and the possibility of irrational play. One could respond that
any of these additional factors would be worthwhile to consider, but it should
be handled by posing a different game that can be analyzed in its own right.
For example, the text shows how the outcome in the Prisoners’ Dilemma
changes when the game is repeated. Regarding the possibility of irrational
play, one could acknowledge the new research on behavioral economics that
is receiving a great deal of attention recently and point the student to Chapter
17.
Some practitioners contend that the crucial skill is less the ability to solve
a game with a sophisticated equilibrium concept than the ability to boil down
a particular economic situation into a simple game that can then be analyzed.
One way to have students practice modeling economic situations as games is
to assign a project that has students take a situation from student life, from
current events in the newspapers, or from movies (Dixit 2005 provides some
nice examples of movies along these lines), and model it as a game, and then
solve for equilibrium.
There is a lot of material in the chapter. To pare it down to something
more manageable, we would suggest omitting the sections on repeated games
and games with continuous actions. It would be nice to cover mixed strategies
and sequential games, but if needed one of these topics could also be omitted.
Drawing the best-response-function diagrams is somewhat difficult, so we
would recommend omitting this topic for less analytical courses. We warn
you that the diagrams are particularly tricky to draw for games with two
actions. We included them in the text so that the student could see the
connection between them and the diagrams for games with continuous actions
(where the diagrams are easier to draw and are quite helpful for the analysis).
We would recommend omitting them in all but the most advanced courses.
 Chapter 5: Game Theory 3

D. Glossary Entries in the Chapter

 Backward Induction
Best Response
Best-Response Function
Dominant Strategy
 Extensive Form
Focal Point
Incomplete Information
Mixed Strategy
Nash Equilibrium
Normal Form
Proper Subgame
Pure Strategy
Stage Game
Subgame-Perfect Equilibrium
Trigger Strategy

SOLUTIONS TO CHAPTER 5/ PROBLEMS

5.1 a. A plays Up; B plays Left.
b. A’s dominant strategy is Up. B does not have a dominant strategy.
c. If v = $3, RTS = 1/2 > w/v = 1/3, the manufacturer will use only L. For q = 20,
L = 20; q = 40, L = 40; q = 60, L = 60. Now the manufacturer’s expansion path
is the L axis.

5.2 a. A plays Down; B plays Right.

b. A’s dominant strategy is Down. B does not have a dominant strategy.
c. Yes. A’s equilibrium payoff increases from 3 to 4. A comparison of the games
in Problems 5.1 and 5.2 suggests the possibility that “burning money” can be
beneficial in a strategic setting.

5.3 a.
A
Up Down

B B
Left Right Left Right

3, 3 5, 1 2, 2 4, 4
4 Chapter 5: Game Theory

b.
A
Up Down

B B
Left Right Left Right

3, 3 5, 1 2, 2 4, 4

c.
B

Left | Up Left | Up Right | Up Right | Up

Left | Down Right | Down Left | Down Right | Down

Up 3, 3 3, 3 5, 1 5, 1
A

Down
2, 2 4, 4 2, 2 4, 4

There are two Nash equilibria: first, A plays Up, and B plays “Left | Up, Left |
Down”; second, A plays Down, and B plays “Left | Up, Right | Down.” The
second is a subgame-perfect equilibrium.

5.4 a. One pure-strategy Nash equilibrium is for Sony to Invest Heavily and Toshiba
to Slacken. The other is the reverse (Sony Slackens and Toshiba Invests
Heavily).
b. Let a be the probability that Sony Invests Heavily and 1 - a that it Slackens.
Given Sony’s mixed strategy,
if Toshiba Invests Heavily, its expected payoff = (a)(0)+(1-a)(3) = 3 - 3a;
if Toshiba Slackens, its expected payoff = (a)(1)+(1-a)(2) = 2 - a.
Equating the two expected payoffs, 3 - 3a = 2 - a, implies a = ½. Letting b be
the probability that Toshiba Invests Heavily and 1 - b that it Slackens.
Calculations similar to the preceding show that b = ½ in the mixed-strategy
Nash equilibrium.
 Chapter 5: Game Theory 5

c. Let I stand for Invest Heavily and S for Slacken. Toshiba’s contingent
strategies are in the column headings of the following normal form:

Toshiba

I|I I|I S|I S|I

I|S S|S I|S S|S

I
0, 0 0, 0 3, 1 3, 1
Sony

S
1, 3 2, 2 1, 3 2, 2

d. Refer to the underlining method in the normal form in part c. There are three
Nash equilibria indicated by the boxes with both payoffs underlined.
e. Proper subgames circled below.
6 Chapter 5: Game Theory

The subgame-perfect equilibrium is for Sony to play I and for Toshiba to play
“S | I, I | S.” In the other Nash equilibria, either Toshiba irrationally plays S
after Sony plays S or Toshiba irrationally plays I after Sony plays I.

5.5 a.
B
Shirk Work

Shirk 0, 0 4, -2

Work -2, 4 1, 1

b. Both shirk.
c. Shirking is a dominant strategy for both. Game resembles the Prisoners’
Dilemma

5.6 a. The normal form becomes

Husband
Ballet Boxing

Wife Ballet 4, 2 0, 0
 Chapter 5: Game Theory 7

Boxing 0, 0 2, 4

The mixed strategies do not change, and the best-response-function diagram

does not change from Figure 5.4 in the text.
b. The normal form becomes

Husband
Ballet Boxing

Ballet 4, 1 0, 0

Wife

Boxing 0, 0 1, 4

The mixed-strategy Nash equilibrium is for the wife to go to ballet and boxing
with probabilities 4/5 and 1/5, respectively, and for the husband to go to ballet
and boxing with probabilities 1/5 and 4/5, respectively.

h
1

Husband’s
best-response
function
Wife’s
best-response
function

1/5
w
4/5 1

c. The normal form becomes

Husband
Ballet Boxing

Wife Ballet
2, 1 1/2, 1/2
8 Chapter 5: Game Theory

Boxing 0, 0 1, 2

The mixed-strategy Nash equilibrium turns out to be the same as in part b.

5.7 a. Using the underlining method shows that playing Rat is a dominant strategy for
both and that both Ratting is a Nash equilibrium.
b. Expected payoff in equilibrium is

1  ( g )(1)  ( g 2 )(1)  ( g 3 )(1)  

 (1)(1  g  g 2  g 3   )
 1 /(1  g ).
If a player deviates to Rat in the first period, his or her payoff is 3 in the first
period and 0 from then on. For the trigger strategies to be an equilibrium, 1/(1-
g)  3, implying g  2/3.
c. The expected equilibrium payoff is the same as in part b, 1/(1-g). If a player
deviates from tit-for-tat, he or she earns 3 in the first period, 0 in the second,
and then the players return to the original equilibrium for an expected payoff of

3  ( g )(0)  ( g 2 )(1)  ( g 3 )(1)  

 2  1  g (1  1)  (1)( g 2  g 3   )
 2  g  (1)(1  g  g 2  g 3   )
 2  g  1 /(1  g ).
For this payoff from deviating to be less than the equilibrium payoff, 2 - g ≤ 0,
implying g  2. This is impossible since g is a probability. So players cannot
sustain cooperation on Silent using tit-for-tat.

5.8 The pure-strategy Nash equilibrium is for A to play Up and B to play Left.

5.9 a. There are four pure-strategy Nash equilibria, one in which none of the three
locate in the mall and three different ones in which two locate in the mall and
the third does not (so three different ones, one for each different left-out store
A, B, and C).
b. Playing cooperatively, they might reach one of the three outcomes in which
two of the stores locate in the mall and the third does not. The sum of the
payoffs is the highest in these outcomes, 4. The stores locating in the mall may
 Chapter 5: Game Theory 9

pay the left-out one for not locating there, perhaps each paying 2/3 so that total
surplus is split evenly.

5.10 a. Following the logic of equation (6.6), the marginal benefit of an additional
sheep for A is
300-2sA-sB.
Setting the marginal benefit equal to the marginal cost 0 gives
sA = 150-sB/2.
Similarly,
sB = 150-sA/2.
Solving simultaneously shows that the Nash equilibrium is

s *A  s *B  100.
b.
sB

300 A’s best-response

function

150
100 B’s best-response
function

sA
100 150 300

c. The marginal benefit of an additional sheep for A is

330-2sA-sB.
Setting the marginal benefit equal to the marginal cost 0 gives
sA = 165-sB/2.
As before,
sB = 150-sA/2.
Solving simultaneously shows that the Nash equilibrium is

s *A  120, s *B  90.
10 Chapter 5: Game Theory

sB

A’s best-response
function shifts out

100 B’s best-response

90 function

sA
100
120