Managerial Decision Making

Luiss University

Instructor: Luca Vitali lvitali@luiss.it

Teaching Assistant: Diletta Topazio dtopazio@luiss.it

1) Firm A decides whether to enter (E) firm B’s industry or not (N). Firm B
observes this decision. If firm A enters, then the two firms simultaneously decide
whether to advertise (a) or not (n). If firm A does not enter, firm B alone decides
whether to advertise. With two firms in the market, the firms earn profits of $3
million each if they both advertise and $5 million if they both do not advertise. If
only one firm advertises, then it earns $6 million and the other earns $1 million.
When firm B is solely in the industry, it earns $4 million if it advertises and $3.5
million if it does not advertise. Firm A earns nothing if it does not enter. Represent
the game in extensive form.
Simultaneous advertising decisions are captured by assuming that, at firm A’s
second information set, firm A does not know whether firm B chose a or n. Also
note that primes are used in the action labels at firm B’s lower information set
to differentiate them from the actions taken at B’s top information set.
2) Consider the following strategic situation concerning the owner of a firm (O), the
manager of the firm (M), and a potential worker (W). The owner first decides whether to
hire the worker, to refuse to hire the worker, or to let the manager make the decision. If
the owner lets the manager make the decision, then the manager must choose between
hiring the worker or not hiring the worker. If the worker is hired, then he or she chooses
between working diligently and shirking. Assume that the worker does not know whether
he or she was hired by the manager or the owner when he or she makes this decision. If
the worker is not hired, then all three players get a payoff of 0. If the worker is hired and
shirks, then the owner and manager each get a payoff of − 1, whereas the worker gets 1. If
the worker is hired by the owner and works diligently, then the owner gets a payoff of 1,
the manager gets 0, and the worker gets 0. If the worker is hired by the manager and
works diligently, then the owner gets 0, the manager gets 1, and the worker gets 1.
Represent this game in the extensive form (draw the game tree).
3) Two players simultaneously throw their right arms up and down to the count of “one,
two, three.” (Nothing strategic happens as they do this.) On the count of three, each player
quickly forms his or her hand into the shape of either a rock (R), a piece of paper (P), or a
pair of scissors (S).
The players make this choice at the same time. If the players pick the same shape, then the
game ends in a tie. Otherwise, one of the players wins and the other loses. The winner is
determined by the following rule:
R>S
S>P
P>R
Each player obtains a payoff of 1 if he or she wins, −1 if he or she loses, and 0 if he or she
ties. Represent this game in the extensive form. Also discuss the relevance of the order of
play (which of the players has the move at the initial node) in the extensive form.
The order does not matter as it is a simultaneous-move game.
𝑆! = 𝑅, 𝑃, 𝑆 , 𝑆" = 𝑅, 𝑃, 𝑆
𝑆 = 𝑆! ×𝑆"
= 𝑅𝑅, 𝑅𝑃, 𝑅𝑆, 𝑃𝑅, 𝑃𝑃, 𝑃𝑆, 𝑆𝑅, 𝑆𝑃, 𝑆𝑆

2
1 R P S

R 0, 0 -1, 1 1, -1

P 1, -1 0, 0 -1, 1

S -1, 1 1, -1 0, 0
4) Represent the following game in the extensive form. There are three players, numbered
1, 2, and 3. At the beginning of the game, players 1 and 2 simultaneously make decisions,
each choosing between “X” and “Y.” If they both choose “X,” then the game ends and the
payoff vector is (1, 0, 0); that is, player 1 gets 1, player 2 gets 0, and player 3 gets 0. If they
both choose “Y,” then the game ends and the payoff vector is (0, 1, 0); that is, player 2 gets
1 and the other players get 0. If one player chooses “X” while the other chooses “Y,” then
player 3 must guess which of the players selected “X”; that is, player 3 must choose
between “1” and “2.” Player 3 makes his selection knowing only that the game did not end
after the choices of players 1 and 2. If player 3 guesses correctly, then he and the player
who selected “X” each obtains a payoff of 2, and the player who selected “Y” gets 0. If
player 3 guesses incorrectly, then everyone gets a payoff of 0.
5) Suppose a manager and a worker interact as follows.
The manager decides whether to hire or not hire the worker. If the manager does not hire
the worker, then the game ends. When hired, the worker chooses to exert either high
effort or low effort.
On observing the worker’s effort, the manager chooses to retain or fire the worker. In this
game, does “not hire” describe a strategy for the manager? Explain.

No, ”not hire" does not describe a strategy for the manager. A strategy for the manager
must specify an action to be taken in every contingency. However, “not hire" does not
specify any action contingent upon the worker being hired and exerting a specific level of
effort.
6) In the extensive-form game that follows, how many strategies
does player 2 have?

Player 2 has four strategies: 𝑐𝑓 , 𝑐𝑔 , 𝑑𝑓 , 𝑑𝑔

7) Consider the normal-form games pictured here. Draw an extensive-form
representation of each game. Can you think of other extensive forms that
correspond to these normal-form games?
a)
b)
8) Evaluate the following payoffs for the game given by the normal form
pictured here. Remember, a mixed strategy for player 1 is 𝜎! ∈ Δ 𝑈, 𝑀, 𝐷 ,
where 𝜎! 𝑈 is the probability that player 1 plays strategy U, and so forth. For
simplicity, we write 𝜎! as 𝜎! 𝑈 , 𝜎! 𝑀 , 𝜎! 𝐷 , and similarly for player 2.
a) 𝑢! 𝑈, 𝐶 = 0
b) 𝑢" 𝑀, 𝑅 = 4
c) 𝑢" 𝐷, 𝐶 = 6
! " "$
d) 𝑢! 𝜎!, 𝐶 = # 0 + # 10 + 0 4 = #
! ! ! "!
e) 𝑢! 𝜎!, 𝑅 = %
3 +" 6 +% 6 = %

f) 𝑢! 𝜎!, 𝐿 = 2
! " !!
g) 𝑢" 𝜎!, 𝑅 = #
3 +# 4 +0 6 = #
!! !! !! !! !! !!
h) 𝑢" 𝜎!, 𝜎" = "%
0 +
"%
10 +
""
3 +
"%
10 +
"%
2 +
""
4 +

1 1 1 9
+0 3 + 0 6 + 0 6 =
4 4 2 2
9) Evaluate 9)
the following payoffs for the following game:
! ! ! !
a) 𝑢! 𝜎! , 𝐼 for 𝜎! = , , ,
" " " "
! ! ! %
b) 𝑢# 𝜎! , 𝑂 for 𝜎! = , , ,
$ " " $
! ! ! ! ! #
c) 𝑢! 𝜎! , 𝜎# for 𝜎! = , , ,
" " " "
, 𝜎# = ,
% %
! ! ! # !
d) 𝑢! 𝜎! , 𝜎# for 𝜎! = 0, % , & , # , 𝜎# = ,
% %
 ! ! ! ! !!
a) 𝑢! 𝜎!, 𝐼 = %
2 +% 2 +% 4 +% 3 = %

! ! ! # "!
b) 𝑢" 𝜎!, 𝑂 = &
2 +
%
2 +
%
3 +
&
3 =
&

!! !" !! !" !! !" !! !" "#

c) 𝑢! 𝜎!, 𝜎" = % # 2 + % # 2 + % # 2 + % # 2 + % # 4 + % # 1 + % # 3 + % # 1 = !"

" ! !" !! !" !! !" !! (

d) 𝑢! 𝜎!, 𝜎" = 0 # 2 + 0 # 2 + # # 2 + # # 2 + ' # 4 + ' # 1 + " # 3 + " # 1 = #
10) Consider the following game. Suppose that player 2 believes that player
! !
1 will select U with probability , C with probability , and D with
# "
!
probability . Also suppose that player 2 plans to randomize by picking M
"
!
and R each with probability . What is player 2’s expected payoff?
#

2 L M R
1
U 8, 1 0, 2 4, 0

C 3, 3 1, 2 0, 0

D 5, 0 2, 3 8, 1
Solution: To calculate player 2’s expected payoff, note that, according to
player 2’s belief, six strategy profiles occur with positive probability: (U, M),
(U, R), (C, M), (C, R), (D, M), and (D, R). Profile (U, M) occurs with
! ! !
probability (that is, probability that player 1 selects U, times
" # #
probability that player 2 selects M). Profile (U, R) also occurs with
! !
probability . Each of the other four profiles occurs with probability . Note
" $
that the six probability numbers sum to one. Multiplying the individual
probabilities by player 2’s payoff in each case, we get a sum of:

1 1 1 1 1 1 10
⋅2+ ⋅0+ ⋅2+ ⋅0+ ⋅3+ ⋅1= = 1.25
4 4 8 8 8 8 8