 |  Principles of Microeconomics, 1st Canadian Edition Robert H. Frank,
Cornell University
Ben S. Bernanke,
Princeton University
Lars Osberg,
Dalhousie University
Melvin Cross,
Dalhousie University
Brian MacLean,
Laurentian University
Thinking Strategically
Graphing ExercisesExtending the Text Before beginning this exercise, be sure you have read Chapter 10 in your text. Without an understanding of the importance of game-type modeling to economics, this will make very little sense. Example 10.5 asks, "What should Michael's acceptance threshold be?" In this example the notion of an ultimatum bargaining game with an acceptance threshold is introduced. This tool allows us to conduct experiments and model behaviour of the ultimatum bargaining type. |
| | 1. | In the case of a proper division of $100, suppose Michael announces he will reject any offer less than $20. What will Tom's response be?
See our suggested answer. |
| | 2. | Is there any reason why Tom would offer less than $80 for himself? What if he offered more?
See our suggested answer. |
| | 3. | What are the weak points of the above exercise?
See our suggested answer. |
| On Your Own: How does allowing a player to change their mind about an ultimatum change the outcome? As you found in question three above, it is entirely possible that Michael will announce a threshold, and then he may or may not adhere to it. Let's add in the probability that Michael will, in fact, keep his word to not accept any amount less than his announced threshold. To begin your analysis, open a new window containing the interactive decision tree graph or, if the window is already open, click the Reset button. Now we need to change the probability Michael Accepts to something other than 100% (he always accepts and the ultimatum has no meaning) or 0% (he only accepts if the ultimatum is met). |
| | 4. | Suppose the probability of Michael actually honouring his threshold is 50%. Now what should Tom do in response to Michael's announcement that he will reject all offers below $50? In this example, let's use $200 to be divided and 50% for the credibility level.
See our suggested answer. |
| | 5. | Suppose Tom proposes an amount below Michael's announced threshold. In the certainty model it is clear that neither of them will receive any of the $200. What about in this model, if the amounts and probability for Michael are as in the previous question?
See our suggested answer. |
| | 6. | Using the model, repeat the exercise with several different credibility probabilities. Is there a pattern to the appropriate action for Tom?
See our suggested answer. |
| Question to Think About... What does the above exercise indicate about the importance of honesty in contracting?
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