ECON 4044 M ICROECONOMICS U NIVERSITY OF N OTTINGHAM N INGBO

A UTUMN 22/23 S CHOOL OF E CONOMICS

Problem set 3 General equilibrium, and game theory*

November 8, 2022†

Directions: PS3 covers Lecture 5 and 6. Please try your best to answer each question as completely as
possible. Part of the solutions will be presented the on the seminar of Week 10 (time: November 18,
2022; venue: PB 205). Solutions that are not presented on the seminar will be posted on Moodle.

I. Consider an exchange economy with two agents, 1 and 2, and two goods, x1 and x2 . Sup-
pose u1 ( x11 , x21 ) = x11 x21 , and u2 ( x12 , x22 ) = x12 x22 . Let the endowments of the two agents be
e1 ≡ (e11 , e21 ) = (3, 2) and e2 ≡ (e12 , e22 ) = (2, 3). Draw an Edgeworth box representation of
this economy, illustrating
(1) the endowment point e ≡ (e1 , e2 ),
(2) the indifference curves passing through e for both agents,
(3) the set of contract curve, and
(4) the set of barter equilibria.

II. (JR 5.18) In a two-good, two-consumer economy, utility functions are

u1 ( x1 , x2 ) = x1 ( x2 )2 and u2 ( x1 , x2 ) = ( x1 )2 x2 .

Total endowments are (10, 20).

(1) A social planner wants to allocate goods to maximise consumer 1’s utility while holding
consumer 2’s utility at u2 = 8000/27. Find the assignment of goods to consumers that
solves the planners problem and show that the solution is Pareto efficient.
* Instructor:Ying Chen. Email: [email protected] (or ask Ying anything anonymously). Office hour: Fridays
4.30-5.30 p.m. (w6-12); Trent 133 the staff lounge (next to Arabica).
† Do not hesitate to email me when you find errors like typos, etc. Any updates of this problem set will be notified via

Moodle announcements.

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ECON 4044 M ICROECONOMICS U NIVERSITY OF N OTTINGHAM N INGBO
A UTUMN 22/23 S CHOOL OF E CONOMICS

(2) Suppose, instead, that the planner just divides the endowments so that e1 = (10, 0) and
e2 = (0, 20) and then lets the consumers transact through perfectly competitive markets.
Find the Walrasian equilibrium and show that the WEAs are the same as the solution in
part (1).

III. Consider the following Robinson Crusoe economy. Robinson the consumer is endowed with
zero units of coconuts, x, and 24 hours of time, h, so that e = (0, 24) . His preferences are defined
over R2+ and represented by u( x, h) = xh. Robinson the producer uses the consumer’s labor
√
services, l, to produce coconuts, y, according to the production function y = l. The producer
sells the coconuts to the consumer. All profits from the production and sale of coconuts are
distributed to the consumer.
(1) Let p denote the price of coconuts, and normalize p = 1. Let w denote the price of Robinsons
time. Find the Walrasian equilibrium prices and allocation of this economy.
(2) Now suppose that Robinson does not think about a market, but simply chooses to enjoy h
hours of leisure and spend 24 − h hours collecting coconuts. What is his optimal choice of
h? How many coconuts does he get? Compare your answer to the answer to part (1).

IV. (JR 7.10) Calculate the set of Nash equilibria in the following games.
(1) Game 1:

L R
U 1,1 0,0
D 0,0 0,0

Also show that there are two Nash equilibria, but only one in which neither player plays a
weakly dominated strategy.
(2) Game 2:

L R
U 1,1 0, 1
D 1,0 -1,-1

Also show that there are infinitely many Nash equilibria, only one of which has neither
player playing a weakly dominated strategy.
(3) Game 3:

L l m M
U 1,1 1,2 0,0 0,0
C 1,1 1,1 10,10 -10,-10
D 1,1 -10,-10 10,-10 1,-10

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ECON 4044 M ICROECONOMICS U NIVERSITY OF N OTTINGHAM N INGBO
A UTUMN 22/23 S CHOOL OF E CONOMICS

Also show that there is a unique strategy determined by iteratively eliminating weakly dom-
inated strategies.

V. Suppose that there are 2 hunters, Fred and Barney. The hunters can go after big game or small
game. If a hunter goes after small game then he catches small game for a payoff of 1. If he goes
after big game and he hunts alone he fails to catch anything, for a payoff of 0. However, if a
hunter hunts for big game and both hunters are hunting big game, then they have a hunting
party and catch the big game for a payoff of 3 each.
(1) Write down the normal form version of this 2-player game.
(2) What is (are) the pure strategy Nash equilibria (PSNE) of this game?
(3) Is there a mixed strategy Nash equilibrium to this game? If so find it.

VI. (JR 7.18) Reconsider the two countries from the previous exercise, but now suppose that coun-
try 1 can be one of two types, ’aggressive’ or ’non-aggressive’. Country 1 knows its own type.
Country 2 does not know country 1’s type, but believes that country 1 is aggressive with prob-
ability ε > 0. The aggressive type places great importance on keeping its weapons. If it does
so and country 2 spies on the aggressive type this leads to war, which the aggressive type wins
and justifies because of the spying, but which is very costly for country 2. When country 1 is
non-aggressive, the payoffs are as before (i.e., as in the previous exercise). The payoff matrices
associated with each of the two possible types of country 1 are given below.

Country 1 is ’aggressive’ Country 1 is ’non-aggressive’

Probablility ε Probablility 1 − ε

Spy Don’t Spy Spy Don’t Spy

Keep 10,-9 5,-1 Keep -1,1 1,-1
Destroy 0,2 0,2 Destroy 0,2 0,2

(1) What action must the aggressive type of country 1 take in any Bayesian-Nash equilibrium?
(2) Assuming that ε < 1
5, find the unique Bayes-Nash equilibrium. (Can you prove that it is
unique?)