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Worksheet 1 Nash Equilibrium

This document provides an introduction to Nash equilibria and contains a worksheet with questions about finding Nash equilibria given best response functions between two firms. The key points are: 1) A Nash equilibrium occurs when both firms are playing their best response to the other's strategy, meaning their outputs satisfy the other's best response function. 2) For continuous best response functions f(x) and g(y) defined on an interval [α,β], if the ranges of f and g are contained in [α,β], then there exists a Nash equilibrium (x*,y*) with α ≤ x*,y* ≤ β. 3) This is shown by using the intermediate value theorem to prove

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104 views4 pages

Worksheet 1 Nash Equilibrium

This document provides an introduction to Nash equilibria and contains a worksheet with questions about finding Nash equilibria given best response functions between two firms. The key points are: 1) A Nash equilibrium occurs when both firms are playing their best response to the other's strategy, meaning their outputs satisfy the other's best response function. 2) For continuous best response functions f(x) and g(y) defined on an interval [α,β], if the ranges of f and g are contained in [α,β], then there exists a Nash equilibrium (x*,y*) with α ≤ x*,y* ≤ β. 3) This is shown by using the intermediate value theorem to prove

Uploaded by

Fran Y
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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National Taiwan University - Calculus 1 for Class 11-14

Worksheet 1 : Nash equilibrium

Name: ID: Department:

Introduction.
Suppose there are two firms A and B producing a certain commodity.
• If A produces x units of commodity, the best response of B is to produce y = f (x) units in order to maximize
its profits. Whereas B produces y units of commodity, the best response of A is to produce x = g(y) units
to maximize its profits. In this context, the functions f (x) and g(y) are called the best response functions
and are assumed to be continuous.

• A Nash equilibrium (x̄, ȳ) is a pair of values that satisfies ȳ = f (x̄) and x̄ = g(ȳ), or in other words, both
A and B are best responding to the other’s strategy.
In this worksheet, we will use the Intermediate Value Theorem to imply the existence of a Nash equilibrium.

Question 1.
Suppose that two oligopolists A and B produce x and y units of a commodity respectively. It is given that :
• The price of the commodity is P (x, y) = 80 − 0.25(x + y).
• The cost function for firm A is C1 (x) = 4x + 100.
• The cost function for firm B is C2 (y) = 3y + 125.
• The revenue of firm A is P (x, y) · x.
• The revenue of firm B is P (x, y) · y.
• The profit of a firm is given by its revenue minus its cost.
(a) Write down the profit (functions) for A and B in terms of x and y.

(b) To find the best response function of A, we regard y as a constant and view the profit of A as a polynomial
in x of degree 2. By completing the square, find xmax that maximizes the profit. Here xmax , which depends
on y, is the best response function of A. In the sequel, we will denote it as g(y).

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(c) Similarly, find the best response function ymax = f (x) of B.

(d) Suppose that A produces x1 = 80 units. Find the best response of B which is denoted by y1 . Then find the
best response of A for y1 which is denoted by x2 and the best response of B for x2 . Repeat this process and
obtain x1 , x2 , x3 . . . and y1 , y2 , y3 . . . . Do the sequences x1 , x2 , x3 . . . and y1 , y2 , y3 . . . converge?

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(e) Solve the system of equations x = g(y) and y = f (x). Explain that the solution is a Nash equilibrium.

Question 2.
In general, we are given continuous best response functions f (x) and g(y).
Furthermore, suppose that there is an interval [α, β] such that

α ≤ f (x) ≤ β and α ≤ g(y) ≤ β for all x, y ∈ [α, β]

i.e. the ranges of f and g on [α, β] are still contained in [α, β]. We will prove that in this case there is always a Nash
equilibrium (x̄, ȳ) satisfying α ≤ x̄, ȳ ≤ β.
(a) First prove the following statement.
A fixed point of a function h(x) is a number c in its domain such that h(c) = c. Use the Intermediate Value
Theorem to prove that any continuous function h(x) with domain [α, β] and range in [α, β] must have a fixed
point. (Hint. Consider the function H(x) = h(x) − x. Show that H(α) ≥ 0, H(β) ≤ 0 and there must be a
number c ∈ [α, β] such that H(c) = 0.)

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(b) Consider the function h(x) = g(f (x)). By (a), show that h(x) has a fixed point x0 ∈ [α, β], i.e. g(f (x0 )) = x0 .
Then explain that (x̄, ȳ) = (x0 , f (x0 )) is a Nash equilibrium.

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