Simplifying this, we obtain the following set of PE allocations: (x E ; x W ) 2

Similar documents
Firms and returns to scale -1- John Riley

Mathematical Foundations II

Economics 2450A: Public Economics Section 8: Optimal Minimum Wage and Introduction to Capital Taxation

Extensive Form Games with Perfect Information

Firms and returns to scale -1- Firms and returns to scale

Answer Key: Problem Set 1

Fundamental Theorems of Welfare Economics

Advanced Microeconomic Analysis, Lecture 6

Industrial Organization, Fall 2011: Midterm Exam Solutions and Comments Date: Wednesday October

Microeconomic Theory -1- Introduction

Some Notes on Adverse Selection

Introduction to General Equilibrium: Framework.

In the Name of God. Sharif University of Technology. Microeconomics 1. Graduate School of Management and Economics. Dr. S.

Market Equilibrium and the Core

General Equilibrium and Welfare

Limit pricing models and PBE 1

3. THE EXCHANGE ECONOMY

Department of Economics The Ohio State University Final Exam Questions and Answers Econ 8712

Lecture 1: Ricardian Theory of Trade

Mathematical Foundations -1- Constrained Optimization. Constrained Optimization. An intuitive approach 2. First Order Conditions (FOC) 7

Teoria das organizações e contratos

Durable goods monopolist

Exclusive contracts and market dominance

Advanced Microeconomics

8. MARKET POWER: STATIC MODELS

9 A Class of Dynamic Games of Incomplete Information:

Microeconomics, Block I Part 2

EconS Microeconomic Theory II Midterm Exam #2 - Answer Key

Equilibrium and Pareto Efficiency in an exchange economy

CHAPTER 3: OPTIMIZATION

EconS 501 Final Exam - December 10th, 2018

Perfect Bayesian Equilibrium. Definition. The single-crossing property. This is a draft; me with comments, typos, clarifications, etc.

G5212: Game Theory. Mark Dean. Spring 2017

EconS Sequential Competition

EconS Microeconomic Theory II Homework #9 - Answer key

5. Externalities and Public Goods

Microeconomic Theory (501b) Problem Set 10. Auctions and Moral Hazard Suggested Solution: Tibor Heumann

Macroeconomics IV Problem Set I

Notes on Alvarez and Jermann, "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica 2000

Advanced Microeconomic Theory. Chapter 6: Partial and General Equilibrium

Simon Fraser University, Department of Economics, Econ 201, Prof. Karaivanov FINAL EXAM Answer key

Upstream capacity constraint and the preservation of monopoly power in private bilateral contracting

Spence s labor market signaling model

5. Externalities and Public Goods. Externalities. Public Goods types. Public Goods

EC476 Contracts and Organizations, Part III: Lecture 2

3.2 THE FUNDAMENTAL WELFARE THEOREMS

EconS Advanced Microeconomics II Handout on Repeated Games

Modeling Technological Change

The Ohio State University Department of Economics. Homework Set Questions and Answers

Game Theory, Information, Incentives

Answer Key for M. A. Economics Entrance Examination 2017 (Main version)

Dynamic Mechanism Design:

NTU IO (I) : Auction Theory and Mechanism Design II Groves Mechanism and AGV Mechansim. u i (x, t i, θ i ) = V i (x, θ i ) + t i,

Final Exam (Solution) Economics 501b Microeconomic Theory

Hans Zenger University of Munich. Abstract

Microeconomics II Lecture 4: Incomplete Information Karl Wärneryd Stockholm School of Economics November 2016

Deceptive Advertising with Rational Buyers

Bayesian Games and Mechanism Design Definition of Bayes Equilibrium

Advanced Microeconomics Problem Set 1

Ph.D. Preliminary Examination MICROECONOMIC THEORY Applied Economics Graduate Program June 2016

Introduction to General Equilibrium

Microeconomics, Block I Part 1

Hicksian Demand and Expenditure Function Duality, Slutsky Equation

Online Addendum for Dynamic Procurement, Quantity Discounts, and Supply Chain Efficiency

Moral Hazard: Part 1. April 9, 2018

The Consumer, the Firm, and an Economy

Macroeconomic Theory and Analysis V Suggested Solutions for the First Midterm. max

Economics 501B Final Exam Fall 2017 Solutions

Uncertainty Per Krusell & D. Krueger Lecture Notes Chapter 6

Microeconomics II. MOSEC, LUISS Guido Carli Problem Set n 3

Bertrand Model of Price Competition. Advanced Microeconomic Theory 1

ECON2285: Mathematical Economics

Bargaining, Contracts, and Theories of the Firm. Dr. Margaret Meyer Nuffield College

Introduction to Game Theory

Economics 121b: Intermediate Microeconomics Midterm Suggested Solutions 2/8/ (a) The equation of the indifference curve is given by,

Lecture Notes - Dynamic Moral Hazard

Differentiable Welfare Theorems Existence of a Competitive Equilibrium: Preliminaries

Dynamic Markets for Lemons: Performance, Liquidity, and Policy Intervention

Department of Economics, University of California, Davis Ecn 200C Micro Theory Professor Giacomo Bonanno ANSWERS TO PRACTICE PROBLEMS 18

Game Theory and Economics of Contracts Lecture 5 Static Single-agent Moral Hazard Model

Economics 200A part 2 UCSD Fall quarter 2011 Prof. R. Starr Mr. Troy Kravitz1 FINAL EXAMINATION SUGGESTED ANSWERS

Practice Questions for Mid-Term I. Question 1: Consider the Cobb-Douglas production function in intensive form:

Controlling versus enabling Online appendix

The Cake-Eating problem: Non-linear sharing rules

Low-Quality Leadership in a Vertically Differentiated Duopoly with Cournot Competition

ECON FINANCIAL ECONOMICS

Minimum Wages and Excessive E ort Supply

A Solution to the Problem of Externalities When Agents Are Well-Informed

Ex 1: Identify the open intervals for which each function is increasing or decreasing.

Reputations. Larry Samuelson. Yale University. February 13, 2013

Walrasian Equilibrium in an exchange economy

Competitive Equilibrium

Industrial Organization Lecture 7: Product Differentiation

ECON607 Fall 2010 University of Hawaii Professor Hui He TA: Xiaodong Sun Assignment 1 Suggested Solutions

Arbitrage and global cones: Another counterexample*

Econ 201: Problem Set 3 Answers

Optimal Insurance of Search Risk

= 2 = 1.5. Figure 4.1: WARP violated

EconS Advanced Microeconomics II Handout on Mechanism Design

Lecture #3. General equilibrium

Transcription:

Answers

Answer for Q (a) ( pts:.5 pts. for the de nition and.5 pts. for its characterization) The de nition of PE is standard. There may be many ways to characterize the set of PE allocations. But whichever way is taken, eventually the following system of equations is obtained. x s;e; = x s ;W (MRS for the state-contingent goods are equalized) x s;e x s;w x s;e + x s;w = 4 (resource constraint for banana at s ) x s;e + x s;w = (resource constraint for banana at s ) Simplifying this, we obtain the following set of PE allocations: (x E ; x W ) f(4; ) ; (4 ( ) ; ( )) j [; ]g : (b) ( pts.) By the rst welfare theorem, the Arrow-ebreu equilibrium allocation must be Pareto-e cient. Hence the equilibrium price ratio p p ; which is equal to MRS x s ;E x = x s ;W s ;E x ; must be s ;W : Thus a banana at s must be twice more expensive as a banana at s : Given this equilibrium price ratio, it is easy to derive the following optimal consumption vectors: x s ; ;E x s ;E = x s ; ;W x s ;W = (; ) ; which of course satisfy the market clearing conditions. If p p (c) ( pts.) For general u i ; we have u i(x s ;i) u i(x s ;i) = p p in equilibrium for i = E; W. = ; then the consumers would obtain a full insurance, i.e. x s ;i x s ;i = for i = E; W: If p p > ; then x s ;i x would be even strictly larger than for i = E; W: s ;i Hence the total consumption of banana at state s is at least as large as the total consumption of banana at state s if p p =. But then the markets would not clear as the total supply of banana is larger at s ; so this is a contradiction. Hence the equilibrium price ratio p p must be strictly less than : (d) (.5 pts.) This is because... The Arrow-ebreu equilibrium allocation is unique in this economy with log utility function. The market is complete with two independent assets for two states. The set of Radner equilibrium allocations coincides with the set of A- equilibrium allocations in a complete market.

(e) (.5 pts.) Since this is an economy with one good, there will be no trade in period given any strictly positive price of banana in each state. Let s normalize the price of banana in each state to. In A- equilibrium, consumer E exchanges bananas at s for 5 bananas at s : Given the equivalence between the Radner equilibrium and the A- equilibrium, consumer E must buy 5 units of Asset B and sells units of Asset A (this is the only way as this is a complete market case). Of course consumer W must sell 5 units of Asset B and buy units of Asset A. This asset trading in period is feasible if q A q = B ; where q k is the equilibrium price of asset k = A; B: So one possible Radner equilibrium would be x E ; x W ; p s ; p s ; qa ; B q = ((; ) ; (; ) ; ; ; ; ) 3

Answer for Q (a) ( pts: pt for writing down the problem correctly and pt for the conditions) The maximization problem is The optimality condition is max xk u (x ) + u (x ) + 3 u (x 3 ) s:t: p x + p x + p 3 x 3 w k u (x k ) p k = for k = ; ; 3 p x + p x + p 3 x 3 = w (b) (3.5 pts.) e ne x k = x k a and w = w (p + p + p 3 ) a > : Note that the objective function can be transformed into a CES function: px + p x + p x 3 and the budget constraint becomes p x +p x +p 3 x 3 w : So the solution is Hence we have x k (p; w) = a + x k (p; w ) = p k p k p + p + w : p 3 p + p + (w (p + p + p 3 ) a) p 3 It is clearly a normal good: @x k (p;w) + @x k(p;w) @w @h k (p; u) = = > : @x k (p;w) @w > for any k: Note that @h k(p;u) x j (p; w) > (Slutsky equation) for any j 6= k: Hence p k @ B @ @p j p + p + p 3 p k C A w p k B a @ p + p + p 3 @ B C @ @p j p + p + A w B + @ p 3 p + p + p 3 p k So any pair of goods are substitutes, not complements. C A + = p k p + p + p 3 (c) (.5 pts.) Let p k k u (x k ) = be the rst order condition for x k for the cost minimization problem. i erentiating this with respect to p j ; j 6= k, C A w B @a + p j p + p + w p 3 C A 4

we obtain @h k(p;u) u = u same sign for all k 6= j. @ : This implies that, for each j; @h k(p;u) has the (d) (3 pts:.5 pts each) (Normal good): The rst order condition is k u (x k ) p k = for k = ; ; 3: If increases, then every consumption must decreases (for xed p). Then, as w increases, must decrease and every consumption must increase so that the budget constraint is binding. Hence every good is a normal good. (Substitutes): Suppose that @h k(p;u) < for some j and k 6= j: Then @h k (p;u) < for any k 6= j by (c): We also know that @hj(p;u) is not positive because S is negative semi-de nite (cost function is concave). Then this is a contradiction because h k (p; u) cannot decrease for every k as p j increases. Hence it must be the case that @h k(p;u) for every j and k 6= j: That is, any pair of the goods must be substitutes for an additive utility function. 5

Answer for Q3. (a) ( points) Since the signal is ` for either quality level, and hence the price p = E[j`; ex()] does not depend on actual quality (but only on buyers beliefs over quality) the worker chooses low quality for any c >. Thus, p` = p h =. From now on assume >. (b) (3 points) Before observing s, buyers believe that quality is high with probability p = F (c ): After observing s = H, they know that quality is high, p h = E[jh; c ] = After observing s = L, Bayes rule implies p Pr(hjH) = : p Pr(hjH) + ( p ) Pr(hjL) {z } = p` = E[j`; c p Pr(`jH) ] = p Pr(`jH) + ( p ) Pr(`jL) = = F (c )( ) F (c )( ) + ( F (c )) = ( )F (c ) F (c ) = F (c ) ; which increases in c. Intuitively, the higher the prior belief of high quality, the higher the posterior belief after signal `, since the market is now attributing this bad signal more to bad luck and less to low quality. (c) (3 points) The bene t of producing high quality is that it increases the probability of a high signal from to, and a high signal raises the price by E[jh; c ] E[j`; c ]. Thus the bene t of a high signal is given by the RHS of (). In equilibrium, this must equal the cost of producing high quality for the threshold type c, the LHS. Since p` increases in c while p h is constant, equal to, the RHS decreases in c. The LHS clearly increases in c. Thus they cross at most once, and hence the equilibrium threshold c is unique. (d) ( points) The RHS of () (E[jh; c ] E[j`; c ]) = ( ( )F (c ) F (c ) ) = F (c ) F (c ) rises in ; intuitively, a rise in increases both the likelihood () that producing high quality results in the h signal, and the informativeness (and hence the value) of this signal p h p`. To restore equality in (), c has to rise, increasing the LHS and decreasing the RHS. Intuitively, when signal quality rises, more types (with higher costs) can be incentivized to produce high quality. 6

Answer for Q4. (a) ( point) By backward induction, the chain store will accomodate entry, and hence the entrant enters. (b) ( points) The entrants strategy is clearly a best response to the chain store. As for the chain store, the critical question is whether he is willing to ght entry today (cost u F = ), to secure a monopoly position for the future (bene t u O = ): ( )u F u O, i.e. u F =(u O + u F ) = =. Now assume that entrant-t observes only the outcome, i.e. O,F, or A, of period t (and assume for convenience that the outcome in period t = was O). Also assume that 6= =. (c) (3 points) The entrants strategy is clearly a best response to the chain store. As for the chain store: If last period s outcome was O or F, and the entrant (unexpectedly) enters the condition for the chain store to follow his strategy and ght is as in part (a): ( )u F u O, or u F =(u O + u F ) = =. The chain store must be su ciently patient to "defend his reputation by ghting entry". But if last period s outcome was A, and the entrant enters, the condition for the chain store to follow is strategy and accomodate is the reverse: ( )u F u O, or u F =(u O + u F ) = =. The chain store must be su ciently impatient to "accept the punishment phase rather than ghting to restore his reputation". These conditions cannot both hold since we ruled out the knifeedge case = u F =(u O + u F ) = =. (d) (4 points) For the entrant (after any history) the expected cost of being fought (cost v F = ) must equal the expected bene t of being accomodated (bene t v A = ), i.e. pv F + ( p)v A =, i.e. p = v A =( v F + v A ) = =. The chain store (after entry in period t) must be indi erent between (i) ghting in t and having entrant t + stay out, and (ii) accomodating in t, having entrant t + enter with probability q, and if so ght entry; both plans have entrants t t + stay out. Plan (i) yields utility u F + u O (in periods t and t + ). Plan (ii) yields utilty ( qu F + ( q)u O ). Equating yields u F = q(u F + u O ), i.e. q = u F =((u O + u F )) = =(). 7

John Riley Micro comp answers 4 July 7 Answer to question 5 (a) point The firms know that any worker s value is at least the lowest value. Therefore r( α) m( α) = + α =. In a separating PBE every signal is chosen by type. Therefore ( q( α), r( a)) = ( q( α), m( α)) = ( q(),) Also for any zˆ < q( α), the wage offer rz ( ˆ) mα ( ) =. Thus q( α ) is a best response if and only if q( α ) = and so ( q( α), r( α ) = (,). Therefore U ( α ) =. (b) 3 points qx ( ) q( ) arg Max{ u(, q( x), r( x) = r( x) C(, q( x)) = + x } x A( ) q( ) U ( ) = + A( ) Envelope Theorem A ( ) q( ) A ( ) U ( ) = = ( + U( )) A( ) A( ) A( ) d [ A ( ) U ( )] = A ( ) U ( ) + U ( ) A ( ) = A ( )( + ) d Case (i) A( ) / =, A ( ) = / (One student observed that Cq (,) is not defined at =. However C(, ) = for all >. Thus the natural assumption is that the function is continuous so C (,) =. To be complete I should have noted that.) d [ U ( )] = ( + ) = + d / / / / U( ) = + + k. / / 3/ 3 IC mapping K (, u) = u / / 3/ 3 U ( ) = + > U O ( ) 3

John Riley Micro comp answers 4 July 7 Case (ii) A( ) = +, A ( ) = Method : d [( + ) U ( )] = ( + ) d Method d [( + ) U ( )] = ( + ) d Then ( ) ( ) ( ) + U = + + IC mapping K (, u) = ( + ) u ( + ) k K ( ) ( ) + U = + + = ( + ) u K (c) points k U ( ) = + + 3 / U ( ) = + 3 Since U () = it follows that k =. Then Method : U ( ) = ( + ) + + k Since U () = it follows that k =. Then U ( ) = + +. + Method : Since U () =, K = 4. Then ( + ) U ( ) = 4 + + U ( ) = + ( + )

John Riley Micro comp answers 4 July 7 (d) point Method U () = U ( ) U ( ) = + 3 Therefore is better for low types And is better for high types Method U ( ) U ( ) = 3 ( + ) = [ 3( + ) ] + This is positive for low types and negative for high types. (e) points The equilibrium level sets of the IC mappings are depicted below. The graph of U ( ) is the level set K (, u) =. The graph of U ( ) is the level set K (, u) =. Consider U ˆ ( ) on the level set depicted K ˆ (, u) = k > U( ) = Max{ U ( ), Uˆ ( )} is incentive compatible. u K (, u) = kˆ K (, u) = K (, u) = ˆ 3

John Riley Micro comp answers 4 July 7 Along the equilibrium level set for technology U ( ) = + 3 Along this line K (, U ( )) = ( + )( + ) ( + ) 3 d K (, U ( )) = + 3 + 3( + ) ( + ) = 3( ) d Thus the indifference maps touch at ˆ =. See the figure below. U( ) = Max{ U ( ), U ( )} is incentive compatible This is the Pareto dominant separating PBE u K (, u) = k K (, u) = K (, u) = = ˆ Then high types (( )use technology while low types us technology. (f) point U ( ) = U ( ) so equilibrium payoffs are unchanged. PBE for types below to stay out. Bonus point 4

John Riley Micro comp answers 4 July 7 But these types are indifferent between staying out and signaling so low types signaling on [,a] and staying out on [a,] is also a PBE. 5

John Riley Micro comp answers 4 July 7 Answer to question 6 (a) points dr Along a level set r = B(, q) = k. Hence the slope is = p(, q). This is increasing in. dq For type, the extra value of choosing ( qr, ) rather then B(, q) B(, qˆ ) p(, x) dx q =. qˆ ( qr ˆ, ˆ), where q> qˆ Is The extra cost is r rˆ The extra benefit is increasing in (this is the SCP). If type ˆ chooses ˆq the extra value of switching to any q B( ˆ, q) B( ˆ, qˆ) = p( ˆ, x) dx r rˆ for all q> qˆ qˆ q > qˆ is lower than the extra cost. For any lower type the demand price is smaller. Thus for all q < ˆ, q B(, q) B(, qˆ) = p(, x) dx< r rˆ for all q> qˆ Thus lower types will either choose qˆ ( qr ˆ, ˆ) or a plan with a lower q. (b) points U( ) = B(, q( )) r( ). Therefore E[()] r = E[ B(, q)] E [ U()] E [ U( )] = U( ) f( ) d = U( α) + U ( )( F( ) d F( ) U( α) U ( )( ) f( ) d f ( ) = + 6

John Riley Micro comp answers 4 July 7 Therefore U( α) U ( ) f( ) d h( ) = + U ( ) = U ( α) +E [ ] h( ) U ( ) E[()] r = E[ B(, q)] E [ ] U( α) (.) h( ) We obtain the marginal information rent by appealing to the Envelope Theorem for IC allocations For all x Θ buyer must prefer ( q( ), r( )) to ( qx ( ), rx ( )). Therefore FOC arg Max{ u(, q( x), r( x)) = B(, q( x)) r( x)} x U( ) = B(, q( )) r( ) B (, qx ( )) r( x) p(, qx ( )) q( x) r( x) x = = at x =, i.e. r ( ) = p(, q( )) q ( ) = ( + q( )) q ( ) (.) Appealing to the Envelope Theorem Therefore B U ( ) = (, q( )). B [ r( )] [ B( E = E, q)] E [ (, q)] U( ) h( ) α To maximize revenue choose a mechanism where the participation constraint for the lowest type is binding. Then U ( α ) =. Therefore where E[()] r = E [ R V (, q)] (.3) V B R (, q) B( =, q) (, q) h( ) (.4) (c) points 7

John Riley Micro comp answers 4 July 7 p(, q) = q V R (, q) = ( + ) q q q ( ) q q h( ) = + h( ). For the uniform case F( ) = =. Therefore h( ) f( ) R V (, q) ( ) q q = +. MR V (, q) = + q. The level set for marginal revenue is depicted below. Note that (,) is on the level set q V MR (, q) = c < MR(, q) = MR(, q) = c > MR V (, q) = Figure 6 : Level sets for virtual marginal revenue Point wise maximization. V MR (, q) = + q = c = so point wise maximization yields q ( ) = This is increasing. Therefore it is IC and so is maximizing for the designer. (d) points 8

John Riley Micro comp answers 4 July 7 Let R( q ) be the cost of a q pack. Then And so Therefore r( ) = R( q( )) r ( ) = R ( q) q ( ) r ( ) R ( q) = q ( ) Appealing to the FOC r ( ) R ( q) = = p(, q( )) = + q( ) q ( ) Since q =, = R ( q) = q q R( q) = q 4 q + k Since ( q(), r ()) = (,) it follows that k =. (e) points With b > h( ) =, b b < < h( ) =, b Thus h( ) is increasing with a discontinuity at = b. The level set for Virtual marginal revenue is depicted below. q V MR (, q) = c < MR V (, q) = 9

John Riley Micro comp answers 4 July 7 Implementation as price a q pack R( q ). The optimal q( ) has an upward discontinuity at qb ( ). Types are separated so r( ) = R( q( )) must also have an upward discontinuity. This is depicted below. The level set for type b touches the function R( q ). r Level set for type b r( ) = R( q( )) q ( b) qb ( ) q Figure 6 3 Implementation as a q pack