CF963 Computational Models in Economics and Finance

Assignment 2
Lecturer: Themistoklis Melissourgos

• Answer all questions below. Submit your answers to FASER. You need to submit:
– one report (word/pdf document) with your answers to all questions. This should be named
according to ‘CF963 RegNumber’.
– the MATLAB (.m) files that you created in the context of this assignment (the file name
should include your registration number).
Submit them separately (do not .zip). Make sure that your code is easy to follow, and copy and
paste your code in the report as requested in the specific tasks.
• Your assignment will be assessed on the quality of the files you submit – correctness, work quality
and quality of presentation. Aim for precise and concise answers and explanations. Good luck!

Task 1 [30%]
No MATLAB code is required for this task.

a. (15%) Consider the following 2 × 2 normal-form game. Compute all the Nash equilibria of the game, and
show your reasoning and calculations in the report.

Luigi
Boost Jump
Throw -2 , -8 1,7
Mario
Defend 3,5 -7 , -1

b. (15%) Consider the following extensive-form game with perfect information. Compute all the subgame
perfect equilibria of the game, and show your reasoning and calculations in the report.
1
L M R

2 2 2
A B C D E F

(2, 1) (1, 2) (2, 3) (5, 3) (1, 0) (6, −1)

Task 2 [40%]
Consider an auction where multiple copies of the same item are being sold/bought. There are n buyers
with identities 1, 2, . . . , n, and (true) valuations v1 , v2 , . . . , vn , respectively, for the item.
At each round, each buyer places a single bid, and two copies of the item are being auctioned.

1
 • If a buyer’s bid is among the 2 highest bids (of that round), she will receive an item and will have
to pay the third highest bid. (For example, if the bids are 5, 5, 4, 2, 1, the third highest bid is 4.)
• If three or more buyers place the same bid, the two buyers with the lowest index (identity number)
among them will receive an item.
• The profit of a buyer for the given round is equal to her true valuation minus her payment if she
receives an item, and zero (0) if she does not receive an item.
The total profit of a buyer is equal to the sum of her individual profits for all rounds. The overall total
profit is equal to the sum of total profits of all buyers.
Consider 7 rounds of the above process. Assume 3 buyers whose valuations for the item are: v1 =
12, v2 = 9, v3 = 4.
a. (20%) Assume that the bid of each buyer is an integer that is selected uniformly at random between 1
and her valuation.
Perform the following in MATLAB:

1. For each round, compute the vector of bids for the buyers.
2. Select the two buyers that receive an item.
3. Calculate the profit of each buyer at each round and in total.
4. Calculate the social welfare of each round and in total.
5. Replicate your experiment 11 times and calculate the average total profit and average social
welfare across your replications.

Your code should output all the quantities you calculated above in a reasonable format. Copy and
paste your code and outputs in the word document, and also manually fill out the two tables below
with the outputs of your code (If the outputs of your code are already presented in the following
format, you can skip the manual creation of the following tables).

(Replication 1) Profit of Buyer 1 Profit of Buyer 2 Profit of Buyer 3 Social Welfare

Average total profit for 11 replications

b. (20%) Perform a brute force search in MATLAB to discover all equilibria in the game that is defined under
the auction rule in the above setting. Your code should output the equilibria clearly, together with
the social welfare of each equilibrium. Copy and paste your code and outputs in the report, and also
manually fill out the two tables below with the outputs of your code (If the outputs of your code
are already presented in the following format, you can skip the manual creation of the following
tables).

Buyer 1 Buyer 2 Buyer 3 Social Welfare

Average social welfare for all equilibria

2
 Task 3 [30%]
No MATLAB code is required for this task.

a. (15%) Consider the Cournot duopoly model where the inverse demand function and the cost functions
are given by

P (q1 , q2 ) = 43 − 3(q1 + q2 ), c1 (q1 ) = 5 + 4q1 , c2 (q2 ) = 10 + q2 ,

where qi is the production quantity of firm i, for i = 1, 2. Give the profit functions of the firms and
compute the Nash equilibrium defined by the quantity each firm chooses to produce. Compute the
profit of each firm, the consumer surplus, and the total surplus at equilibrium. After presenting
your calculations, present your answers in a table of the following form:

q1 ...
q2 ...
π1 (q1 , q2 ) ...
π2 (q1 , q2 ) ...
CS ...
TS ...

b. (10%) Consider the leader-follower duopoly model with the inverse demand function and the cost functions
as defined in Part (a). Let the reaction function of firm 2 be

r2 (q1 ) = 5 + 3q1 .

Give the profit function of firm 1 and find the equilibrium strategies (production quantities) of the
firms. After presenting your calculations, present your answers in a table of the following form:

q1 ...
q2 ...
π1 (q1 , q2 ) ...

c. (5%) Present two models of collusion between the firms and elaborate on whether colluding is profitable
in each model.

Please refer to the Student’s handbook on the Departmental