Problem set 2

() = 100 –  where Q is the aggregate quantity on the market. All firms are equal and face
1) Suppose there are n firms in the Cournot oligopoly model. The inverse demand function is

the following cost function: ( ) = 2 . Firms choose their quantities simultaneously.

a. Find the Nash equilibrium
b. Find the strategy profile where the aggregate quantity is equal to the monopoly quantity and
firms produce the same quantity.
c. Show that the strategy profile at point b) is not an equilibrium (use best responses)
d. Show that firms prefer the strategy profile at point b) respect to the Nash equilibrium (compare

Let  = 2 and suppose firms can choose to produce the Nash quantity or the quantity you find in
profits)
e.
point b. No other quantities are feasible. Represent this situation as a normal form game using a

Let  = 2 and (  ) = 2  (  ) = 3  (firms have different cost functions). Find the Nash
payoff table.
f.
equilibrium.

a. Each firm faces the following problem:

 (100 −  − 2) where  = ∑

The FOC are 98 − ∑  −2 = 0 then the best response of firm  is:

98 − ∑
=

2

Then in equilibrium this condition must be satisfied for every firm, i.e.

!"#∑$% $∗
∗
= 
for every 

Note that you can rewrite these conditions as:

= 98 −  ∗ where  ∗ = ∑
∗ ∗

quantity, i.e. ∗ = ∗ for every , '.

. This is enough to state that every firm produces the same

Then the FOC can be written as:

!"#∑$% ∗
= = (.
∗ ∗ !"

and

!"
(
Therefore in the Nash equilibrium each firm produces a quantity of

problem: ) (100 −  − 2)

b. The quantity that maximizes the profit of a monopolist is given by the solution of the following

The FOC is 98 − 2 = 0. Then the aggregate quantity that maximize the aggregate profits is
 = 49. Then each firm has to produce
+!

.
 98 − ∑
c. Take the best response function

=

2

the level of production that maximizes the profits of firm  is:

+!

If every firm produces

49
98 − ( − 1) 
=
2
+!

Note that this quantity is bigger than , indeed

49
98 − ( − 1)  49
>
2 
49 49
98 − ( − 1) >2
 
49
98 > ( + 1)


That is true for all  ≥ 2.

each, the best response of firm  is to produce a greater quantity.

+!

Then if all other firms produce
+!

Then the strategy profile where all firms produce is not a Nash equilibrium.

d. The profit of firm  in the Nash equilibrium are:

98 98 98 98 98 
/ = 0100 −  − 21 = 098 − 1 =0 1
+1 +1 +1 +1 +1

The profit of firm , when each firm produces

+!

, are:

49 49 49
/2 = 0100 −  − 21 =
  

Note that

49 98 
>0 1
 +1

1 2 
>0 1
 +1

That is true for all  ≥ 2

+!

Then each firm gets more profits if each one produces
e. Players: Firm 1 and Firm 2

Strategies: 3 ∈ 5 , 7 and 3 ∈ 5 , 7
+! !" +! !"
 6  6

Payoff:

49 98
Firm 2

2 3
Firm 1 49 1200.5, 1200.5 1000.4, 1333.9
2
98 1333.9, 1000.4 1067.1, 1067.1
3

g.

100 −  − 2
The best response for firm 1 is
=

2

100 −  − 3
The best response for firm 2 is
=

2

In a Nash equilibrium both must be satisfied, i.e.

100 − ∗ − 2
∗
=
8

2
100 − ∗ − 3
∗
=

2

Solving the system we have:

∗
 = 33 and ∗
 = 32 that is the strategy profile in The Nash equilibrium
 100 − : ; : < : 100 − : ; : < :
2) Consider the Bertrand duopoly model with homogeneous product. The demand function of

=9 ; : = : ; that of firm 2 is  = 9 ; : = : .
==# >? ==# >
@
  
0 ; : > : 0 ; : > :
firm 1 is

The two firms are equal and face the following cost function: ( ) = ∙
Show that the unique Nash equilibrium is : = : = .

1) : > c and : > c is not an equilibrium because the firm with the higher price (zero profits)
has a positive incentive to set a price a bit lower than the other (so it gets strictly positive

2) : < c and : <c is not an equilibrium because the firm with the lower price (strictly negative
profits).

profit) has a positive incentive to set a price a bit higher than the other (so it gets zero

3) : < c and : >c (or : > c and :<c) is not an equilibrium because the firm with the lower
profits).

price (strictly negative profits) has a positive incentive to set a price a bit lower than the

Therefore the only pair of prices that is a best response of each other is : = : = .
other but above c (so it gets strictly positive profits) .

Otherwise we look for best responses.

: > c. It is to set : = : − B where B is infinitely small.

Consider the best response of Firm 1 to:

: = c. It is to set : ≥ : where B is infinitely small.

: < c. It is to set : > :

: > c. It is to set : = : − B where B is infinitely small.

Consider the best response of Firm 2 to:

: = c. It is to set : ≥ : where B is infinitely small.

: < c. It is to set : > :

Therefore the only pair of prices that is a best response of each other is : = : = .
In the figure the best response of firm 2 (shaded area and red lines)

p2

p1
c
a. C () = ==== for 0 ≤  ≤ 100 and C () = 1 for  > 100
3) Consider the model of final offer arbitration. Find the Nash equilibrium when
D@

b. C () = 0.01 ∙  with 0 ≤  ≤ 100

a. To find the median you have to solve ==== = 0.5 by x.

D@

 = 5000
 = 70.7 = I
JK (JL
Then one condition for a NE is 
= 70.7

Then we need to find ;() =

MN(D)
MD


; () =
5000

Then the second condition is:

1 5000
OP − OQ = I = 70.7 = 70.7
5000

We have to solve the system

OP − OQ = 70.7
9OQ + OP
= 70.7
2

The solution is

OP ≅ 106

O; ≅ 35.3

But if OP >0 which is the solution?

We have to use Kuhn Tucker condition for constrained maximization.

1
b. We have to solve the system

OP − OQ =
8 O + O 0.01
= 50
Q P
2

OP = 100

O; = 0
4. Consider the Problem of the Commons. Assume that  = 3and that T() = 120 − . Compute
the Nash equilibrium, the total number of goats in the Nash equilibrium and the number of
goats that maximize the social welfare.

IU V (120 − − V − V − V6 )
The problem of farmer 1 is

(120 − − V − V6 )
Compute the FOC to find its best response, that is:

V =
2
As in Cournot model is possible to show that V = V = V6 , then we have that:
(120 − )
V = V = V6 =
4
That is the a Nash equilibrium

3(120 − )
The total number of goats in equilibrium is :

W=
4
The number of goats that maximizes the social welfare is the number that maximizes the
aggregate profits

IX W(120 − − W)
The problem is:

(120 − )
Using the first order condition we find that:

W=
2
That is smaller than in the Nash equilibrium
5. Represent by a table a traveler’s dilemma game with two players. They can choose integer
numbers between 1 and 4 and R=2. Find the Nash equilibrium

Player 2
1 2 3 4
1 1, 1 3, -1 3, -1 3, -1
2 -1, 3 2, 2 4, 0 4, 0
Player 1
3 -1, 3 0, 4 3, 3 5, 1
4 -1, 3 0, 4 1, 5 4, 4

The unique Nash equilibrium is: Player 1 plays 1, Player 2 plays 1

6. Represent a beauty contest game with two players. They can choose integer numbers between
1 and 4 :
c. when p=0.5
d. when p=1
e. when p=2

In all cases find the Nash equilibria

Let 100 be the prize. When both players are at same distance from : ∗ TYZVY, each one
receives 50

P=0.5

Player 2
1 2 3 4
1 50, 50 100, 0 100, 0 100, 0
2 0, 100 50, 50 100, 0 100, 0
Player 1
3 0, 100 0, 100 50, 50 100, 0
4 0, 100 0, 100 0, 100 50, 50

Unique Nash Equilibrium: Player 1 plays 1, Player 2 plays 1

p=1

Player 2
1 2 3 4
1 50, 50 50, 50 50, 50 50, 50
2 50, 50 50, 50 50, 50 50, 50
Player 1
3 50, 50 50, 50 50, 50 50, 50
4 50, 50 50, 50 50, 50 50, 50

All strategy combinations are Nash equilibria

p=2

Player 2
1 2 3 4
1 50, 50 0, 100 0, 100 0, 100
2 100, 0 50, 50 0, 100 0, 100
Player 1
3 100, 0 100, 0 50, 50 0, 100
4 100, 0 100, 0 100, 0 50, 50

Unique Nash Equilibrium: Player 1 plays 4, Player 2 plays 4