Econ603: Microeconomic Theory II (Game Theory) Iowa State University

Handout ?? Spring 2012

Solutions to Problem Set 6

Problem 1. 1(a) In the second price auction each bidder bids his valuation. The expected payment conditional on him winning is n1 v which is the expectation of the n highest value out of n1 uniform random variables over [0, v] (because he has to be pay the second highest bid). He will win with probability v n1 and therefore generates expected revenue to the auctioneer of v n1 n1 v. n (1)

1(b) In the hybrid it seems reasonable to guess that the equilibrium gives the good to the agent with the highest valuation - hence the winning probability is v n1 . Assume that agents bids are linear functions, i.e. b (v) = av for some 1 a < 1. Then the expected payment is av with probability 2 and a n1 v (second n highest bid). By equalizing expected revenue in the second price and the hybrid auction we get: [ ] n1 a n1 v= 1+ v (2) n 2 n Not, that the winning probability just cancels out. So we can solve for the bidding function b(v) in the hybrid auction: b(v) =
n1 v [ n n1 ] 1 v 2 1+ n

(3)

1(c) For a given v hybrid bids are greater than rst-price bids but smaller thsn second-price auction bids as one might expect. Problem 2. { } 2(a) Since S is nite we can write S = s1 , s2 , .., sn such that sk < sk+1 and 0 < si < 1. The type of a player is simply the prize si S she is ) ( holding. The ( ) probability that player i is of type sk is pk such that pk = F sk F sk1 . Each player can take an action a {0, 1} and we interpret 1 as agreement and 0 as refusal to swap the prizes. We can denote the strategies of both players with ai (s). The utility of player i is: { si if ai = 0 or ai = aj ui (ai , aj ) = sj if ai = aj = 1

Econ603 Handout ??: Solutions to Problem Set 6

2(b) We use a dominance argument similar to the ones discussed in the examples in class. Lets look at a BNE and denote the set of types who choose action ai = 1 with Si S. We denote the maximum element of the set Si with si . Note, that the maximal elements of the sets S1 and S2 do not have to be equal unless it is a symmetric equilibrium. Without loss of generality we can assume s1 s2 . Clearly if player 1 has type s1 he cannot win by participating in exchange. In fact, he will lose for sure if s1 > s2 . Hence, any valid equilibrium must have s1 = s2 . If s2 > s1 then player 1 will still lose because there is some probability that he will exchange his prize for a prize which is worth less. Therefore s1 = s2 = s1 . Problem 3. Consider the following game.

4,4

1,1

1,2

0,0

0,1/2

0,2/2

Player 1 knows the i . There are two realization of these parameters. With 1 1 probability 2 the realization is 1 = 6 and 2 = 0, and with probability 2 the realization is 1 = 0 and 2 = 6. Call these two possible normal form games T1 and T2 . Only player 1 knows the type of game being played (we can interpret ( ) the game type Ti as player 1s type). Player 2 only has prior 1 , 1 . You can 2 2 easily show that the only BNE is (U,L). If player 1 plays U the expected value of both 1 and 2 is 3 for player 2. She will therefore play L. In neither case does player 1 have an incentive to play D because she would get 0 in any case. In contrast, under full information the unique NE is (D,M) if the game is T1 and (D,R) if the game is T2 . In both cases player 2 gets payo 3 instead of 4. The intuition is that under full information player 2 cannot commit any longer not to play D or R. Information destroys commitment power in this example.

Econ603 Handout ??: Solutions to Problem Set 6

Problem 4. 4(a) Your optimal bid is 0. If you bid any positive value and you win the object then the value was between 0 and your bid b. Hence the expected value is V = b/2 and the prot you can make from it is = 3 b/2 = 3 b which is still 2 4 less than what you paid for. 4(b) Winning is bad news in this game because it means that the true value is lower than your bid. Put dierently, the seller has information about the value of the object - if you win the auction then his assessment of the value was value. Problem 5. 5(a) Assume there is a pure-strategy NE. If the highest bid is less than 1 then a player could deviate and bid more and win the dollar. If the highest bid is 1 dollar then all other players should bid 0 instead of wasting their bid. But then the highest bidder could do better by bidding . 5(b) Assume that both players mix over [0, 1] (this can be shown to be true). Assume that their bid function has density f . Then bidding b wins the good b with probability F (b) = 0 f (t)dt. A bidder has to be indierent between all bids in her support - if she bids 0 she gets exactly 0. Therefore, we have: F (b) b = 0 This implies that f = 1 - both players mix uniformly over their support. 5(c) With n players we get F (b)n1 = b. The distribution of bids is therefore 1 F (b) = b n1 which is more skewed towards low bids as one might expect. (4)