Assignment-1

Game Theory-II
BA (H) Economics, Sem III – Sec A and B
Instructor: Ankush Garg, JSGP

Q1. Consider the scene from the movie, ‘The Dark Knight’. Joker has issued a public threat to blow
up Gotham city. Consequently, residents of the city try to leave the city. The city is surrounded by
water body from all directions and taking a boat is the only way out of the city. Joker wants to
prove to Batman that the common people are selfish and have no care or regards for each other.
In order to prove it, joker puts detonators in two boats (B1 and B2), one with ‘civilians’ as
passengers and another with ‘prisoners’ as passengers. Midway of their rides, Joker makes a
simultaneous announcement via the radio on the two boats that each of these two boats has a
detonator and pressing the detonator on one boat will blow up the other boat. Each boat has to
decide whether to press the detonator or not. If both press the detonator, the lives on both boats
are lost. If both do not press, then the lives on both the boats are saved. If only one presses the
detonator, the lives on the other boat are lost making the people on the boat that pressed the
detonator, the sole survivors. Suppose, there are two types of people – the ones who have
‘survivor’s gloat’ (SGL)1 and the ones who have ‘survivor’s guilt’ (SGT). Assume, on a boat, people
have homogeneous type. The types are independently and identically distributed such that SGT
and SGL types are equally likely for each player. The payoffs of each state-game are given as
follows:

B2 (prisoners) B2 (prisoners)
press not press not
B1 press 10, 10 80, 0 B1 press 10, 10 80, 0
(civilians) not 0, 80 50, 50 (civilians) not 0, -10 50, 50
(SGL, SGL) (SGL, SGT)

B2 (prisoners) B2 (prisoners)
press not press not
B1 press 10, 10 -10, 0 B1 press 10, 10 -10, 0
(civilians) not 0, 80 50, 50 (civilians) not 0, -10 50, 50
(SGT, SGL) (SGT, SGT)

a. Define type set and strategy set for each player. 1 mark

Type: 𝑡1 ∈ 𝑇1 = {𝑆𝐺𝐿, 𝑆𝐺𝑇}; 𝑡2 ∈ 𝑇2 = {𝑆𝐺𝐿, 𝑆𝐺𝑇};

1Survivor’s gloat is the feeling of malign pleasure on one’s own success on surviving or another’s inability to
survive a fatal situation
 Strategy: 𝑠1 = (𝑠1 (𝑆𝐺𝐿), 𝑠1 (𝑆𝐺𝑇)) and 𝑠2 = (𝑠2 (𝑆𝐺𝐿), 𝑠2 (𝑆𝐺𝑇)) where,

𝑠1 (𝑡1 ) ∈ 𝐴1 = {𝑝𝑟𝑒𝑠𝑠, 𝑛𝑜𝑡} for each 𝑡1 ; 𝑠2 (𝑡2 ) ∈ 𝐴2 = {𝑝𝑟𝑒𝑠𝑠, 𝑛𝑜𝑡} for each 𝑡1

b. Derive the best responses of each player. 1 mark

Since the types are independently distributed, the posterior beliefs are (0.5, 0.5)

Best responses:
Notice that whenever in a state game a player is SGL type, its dominant action is to
choose ‘press’. Consequently,

𝐵𝑅1 (𝑆𝐺𝐿; 𝑠2 ; (0.5, 0.5)) = 𝑝𝑟𝑒𝑠𝑠 for all 𝑠2 and

𝐵𝑅2 (𝑆𝐺𝐿; 𝑠1 ; (0.5, 0.5)) = 𝑝𝑟𝑒𝑠𝑠 for all 𝑠1

Further, using the expected utility calculations,

𝐵𝑅1 (𝑆𝐺𝑇; 𝑠2 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠2 (𝑆𝐺𝑇) = 𝑝𝑟𝑒𝑠𝑠 ; (0.5, 0.5)) = 𝑝𝑟𝑒𝑠𝑠
𝐵𝑅1 (𝑆𝐺𝑇; 𝑠2 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠2 (𝑆𝐺𝑇) = 𝑛𝑜𝑡 ; (0.5, 0.5)) = 𝑛𝑜𝑡

𝐵𝑅2 (𝑆𝐺𝑇; 𝑠1 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠1 (𝑆𝐺𝑇) = 𝑝𝑟𝑒𝑠𝑠 ; (0.5, 0.5)) = 𝑝𝑟𝑒𝑠𝑠

𝐵𝑅2 (𝑆𝐺𝑇; 𝑠1 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠1 (𝑆𝐺𝑇) = 𝑛𝑜𝑡 ; (0.5, 0.5)) = 𝑛𝑜𝑡

c. Derive the pure strategy Bayesian Nash equilibria of the game. 2 marks

There are two BNE in this game. One is a separating equilibrium and the other is pooling
equilibrium.

Separating: (𝑠1 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠1 (𝑆𝐺𝑇) = 𝑛𝑜𝑡; 𝑠2 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠2 (𝑆𝐺𝑇) = 𝑛𝑜𝑡)

Pooling: (𝑠1 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠1 (𝑆𝐺𝑇) = 𝑝𝑟𝑒𝑠𝑠; 𝑠2 (𝑆𝐺𝐿) = 𝑝𝑟𝑒𝑠𝑠, 𝑠2 (𝑆𝐺𝑇) = 𝑝𝑟𝑒𝑠𝑠)

d. Is the Joker right about the nature of common people? 1 mark

The answer depends on what outcome is observed. If it is observed that none of the boats
pressed the detonator, then we can argue that everyone is survivor’s guilt type. Then the
Joker is wrong. However, if it is observed that exactly one boat pressed the detonator,
then we can argue that everyone is survivor’s gloat type. Then the Joker is right. Lastly, if
it is observed that both boats, pressed the button, then we cannot be sure what type
people are. In other words, the only instance in which Joker’s claim can be refuted with
certainty is when both boats do not press the detonator.

Q2. Suppose Harry and Ron find a mysterious box. They both are curious about what’s inside the
box. The instructions written on the box says that the box opens when the big red button on the
box is pressed. However, two people simultaneously have to press the button for it to open. If
only one presses it, then the box is destroyed. Furthermore, since none of the two know what’s
inside the box, they are worried that they might unleash something dangerous by opening the
box. Suppose, they think with probability ‘q’, opening the box is safe and with the remaining prob.
(1-q), opening the box is dangerous. The payoff of each player is given as follows:

P2 P2
press not press not
P1 press 100, 100 40, 30 P1 press 20, 20 30, 40
not 30,40 50, 50 not 40,30 50, 50
Safe (q) dangerous (1-q)

a. Formally write the game. 2 marks

Players: 𝑁 = {𝐻𝑎𝑟𝑟𝑦 (𝑃1), 𝑅𝑜𝑛(𝑃2)}

Actions: 𝐴𝑖 = {𝑝𝑟𝑒𝑠𝑠, 𝑛𝑜𝑡} for all 𝑖 ∈ 𝑁
Types: 𝑇1 = {𝑡1 }, 𝑇2 = {𝑡2 }, 𝑇3 = {𝑠𝑎𝑓𝑒, 𝑑𝑎𝑛𝑔𝑒𝑟𝑜𝑢𝑠}, where P3 is non-strategic player
(Nature/Experimenter) whose only role is to choose prior (𝑞, 1 − 𝑞)
State game payoffs are given as above

b. Derive the pure strategy Bayesian Nash equilibria of the game. 3 marks

Strategies: Since both Ron and Harry have singleton type sets, they do not have type
dependent strategies. That is, 𝑠1 ∈ {𝑝𝑟𝑒𝑠𝑠, 𝑛𝑜𝑡} and 𝑠2 ∈ {𝑝𝑟𝑒𝑠𝑠, 𝑛𝑜𝑡}.

Beliefs: Since there’s no learning about the type of P3, posterior= prior.

𝑝𝑟𝑒𝑠𝑠 𝑖𝑓 𝑞 > 2/9

𝐵𝑅1 (𝑠2 = 𝑝𝑟𝑒𝑠𝑠) = { 𝑛𝑜𝑡 𝑖𝑓 𝑞 < 2/9
{𝑝𝑟𝑒𝑠𝑠, 𝑛𝑜𝑡} 𝑖𝑓 𝑞 = 2/9

This is because, 𝐸𝑈1 (𝑝𝑟𝑒𝑠𝑠) = 100𝑞 + 20(1 − 𝑞) = 20 + 80𝑞

𝐸𝑈1 (𝑛𝑜𝑡) = 30𝑞 + 40(1 − 𝑞) = 40 − 10𝑞

𝐵𝑅1 (𝑠2 = 𝑛𝑜𝑡) = 𝑛𝑜𝑡 for all 𝑞

This is because, 𝐸𝑈1 (𝑝𝑟𝑒𝑠𝑠) = 40𝑞 + 30(1 − 𝑞) = 30 + 10𝑞
𝐸𝑈1 (𝑛𝑜𝑡 ) = 50𝑞 + 50(1 − 𝑞) = 50

Since the game is symmetric across the two players,

𝑝𝑟𝑒𝑠𝑠 𝑖𝑓 𝑞 > 2/9

𝐵𝑅2 (𝑠1 = 𝑝𝑟𝑒𝑠𝑠) = { 𝑛𝑜𝑡 𝑖𝑓 𝑞 < 2/9
{𝑝𝑟𝑒𝑠𝑠, 𝑛𝑜𝑡} 𝑖𝑓 𝑞 = 2/9

𝐵𝑅2 (𝑠1 = 𝑛𝑜𝑡) = 𝑛𝑜𝑡 for all 𝑞

There are two BNE of the game.

BNE1: (𝑛𝑜𝑡, 𝑛𝑜𝑡) for all values of 𝑞

BNE2: (𝑝𝑟𝑒𝑠𝑠, 𝑝𝑟𝑒𝑠𝑠) for 𝑞 ≥ 2/9
Q3. Country X and Y are at the brink of a war. Country X is a superpower in defence, while country
Y is small and lacks resources to defend itself if it is attacked by X. There’s a coalition of countries
that consider country X as their enemy. The coalition offers country Y to join them and in return
they will provide protection to Y against attack by X. Country X anticipates this and announces an
open threat that if country Y joins the coalition, then it will definitely attack Y in most aggressive
manner that even the additional protection by the coalition will not save country Y. Country Y
realizes that joining the coalition does provide protection but is unsure of credibility of country X’s
threat. Suppose with prob. ‘p’ country Y thinks that the threat given by X is not credible and with
remaining ‘1-p’ prob., it is credible. Suppose the following payoff are realized to each country in
different scenario.

X X
Attack Not Attack Attack Not Attack
(A) (NA) (A) (NA)
Y Join (J) 80, 30, 30 Y Join (J) 10, 30, 30
20 100
Not Join 0, 40 40, 30 Not Join 30, 50 40, 40
(NJ) (NJ)

Threat is not credible (p) Threat is credible (1-p)

a. Write formally the strategies of each player. 2 mark

Strategy: 𝑠𝑌 = (𝐽, 𝑁𝐽) and 𝑠𝑋 = (𝑠𝑋 (𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒), 𝑠𝑋 (𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒)) where,

𝑠𝑋 (𝑡𝑋 ) ∈ 𝐴𝑋 = {𝐴, 𝑁𝐴} for each 𝑡𝑋 ∈ {𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒, 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒}

b. For which values of ‘p’, country Y joins the coalition in equilibrium? 3 marks

Best responses:

𝐵𝑅𝑋 (𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒; 𝑠1 = 𝐽) = 𝑁 ; 𝐵𝑅𝑋 (𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒; 𝑠1 = 𝑁𝐽) = 𝐴

𝐵𝑅𝑋 (𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒; 𝑠1 = 𝐽) = 𝐴 ; 𝐵𝑅𝑋 (𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒; 𝑠1 = 𝑁𝐽) = 𝐴

Thus, whenever country X’s type is ‘credible’, it chooses attack (A)

𝐽 𝑖𝑓 𝑝 > 1/5
𝐵𝑅𝑌 (𝑡𝑦 ; 𝑠𝑋 (𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝐴, 𝑠𝑋 (𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝐴; (𝑝, 1 − 𝑝)) = {𝑁𝐽 𝑖𝑓 𝑝 < 1/5
{𝐽, 𝑁𝐽} 𝑖𝑓 𝑝 = 1/5

𝐵𝑅𝑌 (𝑡𝑦 ; 𝑠𝑋 (𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝑁, 𝑠𝑋 (𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝐴; (𝑝, 1 − 𝑝)) = 𝑁𝐽 for all 𝑝

For country Y, join (J) the coalition is a best response (for 𝑝 > 1/5) only when country X
chooses a strategy (𝑠𝑋 (𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝐴, 𝑠𝑋 (𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝐴).
 Consider the strategy profile,
(𝑠𝑦 = 𝐽; 𝑠𝑋 (𝑛𝑜𝑡 𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝐴, 𝑠𝑋 (𝑐𝑟𝑒𝑑𝑖𝑏𝑙𝑒) = 𝐴). This is not a BNE because when country
X is ‘not credible’ type, its best response is to not attack.

Therefore, there’s no BNE in which country Y joins the coalition.

Q4. Taxpayers evade some amount of their lax liability even if they face some positive chance of
getting caught punished. The tax department can randomly audit taxpayer’s accounts but it is a
costly exercise. Consider a tax compliance game.
Suppose the taxpayer has a taxable income of 100. The tax liability of the tax payer is 20. The
taxpayer has two options, either to ‘evade (E)’ the tax fully or ‘not evade (NE)’ at all. The tax
department can choose either to ‘audit (A)’ the account of the taxpayer or ‘not audit (NA)’.
Auditing has a cost 𝑐 ∈ {30, 80}. The tax department knows its own cost of auditing but the
taxpayer does not. Taxpayer believes that the two values of the audit cost are equally likely.
Furthermore, if the department audits and if the taxpayer has evaded the tax, then it is caught
with certainty. When caught, not only the taxpayer has to pay the full tax, it has to also pay a fine
that is equal to double of the tax amount. The net revenue of the tax department is sum of the
tax collection and the fine minus the cost of auditing. Whereas, the net payoff of the taxpayer is
the net income post tax (if paid) and the fine (if any).

a. Write the payoff matrices and the strategy sets of each player. 2 marks

Tax Dept (D)

Audit (A) Not Audit (NA)
Tax- Evade 40(=100-20-40), 100, 0
payer (E) 30(=20+40-30)
(P) Not 80(=100-20), 80(=100-20), 20
Evade -10(=20-30)
(NE)
c=30

Tax Dept (D)

Audit (A) Not Audit (NA)
Tax- Evade 40(=100-20-40), 100, 0
Payer (E) -20(=20+40-80)
(P) Not 80(=100-20), 80(=100-20), 20
Evade -60(=20-80)
(NE)

c=80
b. Does there exist a pure strategy BNE? If, yes derive the equilibrium. 3 marks

The auditing cost is private information of the tax department. In other words, auditing
cost is tax department’s type, that is, 𝑡𝐷 ∈ 𝑇𝐷 = {30, 80}.

Strategy of tax department: 𝑠𝐷 = (𝑠𝐷 (30), 𝑠𝐷 (80)) , where 𝑠𝐷 (𝑡𝐷 ) ∈ {𝐴, 𝑁𝐴} for all 𝑡𝐷

1
Belief of taxpayer on 𝑡2 is 𝑝𝑟(𝑡2 = 30) = 2 = 𝑝𝑟(𝑡2 = 80)

Best response of tax department:

𝐵𝑅𝐷 (𝑐 = 30; 𝐸) = 𝐴 𝐵𝑅𝐷 (𝑐 = 30; 𝑁𝐸) = 𝑁𝐴

𝐵𝑅𝐷 (𝑐 = 80; 𝐸 ) = 𝑁𝐴 𝐵𝑅𝐷 (𝑐 = 80; 𝑁𝐸 ) = 𝑁𝐴

Best response of taxpayer: using expected payoff calculations,

1 1
𝐵𝑅𝑇 (𝑠𝐷 (30) = 𝐴, 𝑠𝐷 (80) = 𝑁𝐴; (2 , 2)) = 𝑁𝐸

𝐵𝑅𝑇 (𝑠𝐷 (30) = 𝑁𝐴, 𝑠𝐷 (80) = 𝑁𝐴) = 𝐸

There’s no pure strategies BNE of this game