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Econs 424 - Signalling Games I: Félix Muñoz-García

This document describes a signaling game between a firm and a worker. There is a probability p that the firm is high quality and 1-p that it is low quality. The firm can choose to offer a job (O) or not (N). If offered a job, the worker can accept (A) or reject (R). The payoffs for each action are provided. Three potential perfect Bayesian equilibrium strategies are analyzed: (1) NH,OL is rejected since the low quality firm would not want to offer a job, (2) OH,NL is rejected since both types of firms would want to offer a job, and (3) OH,OL is a pooling equilibrium where both firm types offer a job and the

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0% found this document useful (0 votes)
42 views33 pages

Econs 424 - Signalling Games I: Félix Muñoz-García

This document describes a signaling game between a firm and a worker. There is a probability p that the firm is high quality and 1-p that it is low quality. The firm can choose to offer a job (O) or not (N). If offered a job, the worker can accept (A) or reject (R). The payoffs for each action are provided. Three potential perfect Bayesian equilibrium strategies are analyzed: (1) NH,OL is rejected since the low quality firm would not want to offer a job, (2) OH,NL is rejected since both types of firms would want to offer a job, and (3) OH,OL is a pooling equilibrium where both firm types offer a job and the

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Meera Devi
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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EconS 424 - Signalling Games I

Félix Muñoz-García

Washington State University


[email protected]

April 28, 2014

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 1 / 33


Watson, Ch. 29 Exercise 3

There is a …rm and a worker. In this game, nature chooses the "type"
of the …rm (player 1). With probability p, the …rm is of high quality
(H) and, with probability 1 p, the …rm is of low quality (L).
The …rm chooses either to o¤er a job to the worker (O) or not to
o¤er a job (N).
If no job is o¤ered, the game ends and both parties receive 0.
If the …rm o¤ers a job, the worker either accepts (A) or rejects (R) the
o¤er.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 2 / 33


Watson, Ch. 29 Exercise 3

Firm:
The worker’s e¤ort on the job brings the …rm a pro…t of 2.
If the worker rejects an o¤er of employment, then the …rm gets a
payo¤ of -1 (associated with being jilted).

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 3 / 33


Watson, Ch. 29 Exercise 3

Worker:
Rejecting an o¤er yields a payo¤ of 0 to the worker.
Accepting an o¤er yields the worker a payo¤ of 2 if the …rm is of high
quality, and -1 if the …rm is of low quality.
The worker does not observe the quality of the …rm directly.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 4 / 33


Watson, Ch. 29 Exercise 3

Let us …nd all PBEs of this game.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 5 / 33


Watson, Ch. 29 Exercise 3

A 2,2

NH 1 OH q
0,0
R
p
-1,0
2
2,-1
(1-p) A

0,0
NL 1 OL (1-q) R

-1,0

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 6 / 33


Watson, Ch. 29 Exercise 3
First strategy pro…le candidate to be PBE: N H O L : Let us start
with the separating equilibrium where the informed player 1 (the …rm)
makes a job o¤er to the worker (O) only when the …rm is of low
quality, O L , but not to make a job o¤er otherwise, i.e., N H .
The …gure below shades the branches corresponding to this strategy.
A 2,2

NH 1 OH q
0,0
R
p
-1,0
2
2,-1
(1-p) A

0,0
NL 1 OL (1-q) R

-1,0

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 7 / 33


Watson, Ch. 29 Exercise 3

Given this strategy from the …rm, the worker’s beliefs after observing
a job o¤er must be
p 0
q= =0
p 0+(1 p) 1
Intuitively, this implies that after observing O, the worker
concentrates all his beliefs on being in the lower node of the
information set, i.e., low-quality …rm.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 8 / 33


Watson, Ch. 29 Exercise 3

Given these beliefs, it is optimal for the worker to reject the job o¤er,
since 0 > 1.
For future reference, we shade the branch in which the worker rejects
the …rm’s job o¤er, an action that is independent on the …rm’s type
(something that the worker cannot observe).
If the worker rejects, then the high-quality …rm prefers to not make a
job o¤er, N H , since 0 > 1, as prescribed by this strategy pro…le.
However, the low-quality …rm prefers to not make job o¤ers, N L , which
contradicts the initially proposed strategy pro…le N H O L .
Then, the separating strategy pro…le N H O L cannot be sustained as a
PBE of this game.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 9 / 33


Watson, Ch. 29 Exercise 3
Second strategy pro…le candidate to be PBE: O H N L Let us
continue with the separating equilibrium where the informed player
(…rm) makes a job o¤er to the worker (O) only when the …rm is of
high quality, O H , but not to make a job o¤er otherwise, i.e., N L .
The …gure below shades the branches corresponding to this strategy.
A 2,2

NH 1 OH q
0,0
R
p
-1,0
2
2,-1
(1-p) A

0,0
NL 1 OL (1-q) R

-1,0

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 10 / 33


Watson, Ch. 29 Exercise 3

Given this strategy from the …rm, the worker’s beliefs after observing
a job o¤er must be
p 1
q= =1
p 1 + (1 p) 0

Intuitively, this implies that after observing O, the worker


concentrates all his beliefs on being in the upper node of the
information set, i.e., high-quality …rm.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 11 / 33


Watson, Ch. 29 Exercise 3

Given these beliefs, it is optimal for the worker to accept the job o¤er,
since 2 > 0.
For future reference, we shade the branch in which the worker accepts
the …rm’s job o¤er, an action that is independent on the …rm’s type
(something that the worker cannot observe).
If the worker accepts, then the high-quality …rm prefers to make a job
o¤er, OH, since 2 > 0, as prescribed by this strategy pro…le.
The low-quality …rm also prefers to make a job o¤er, O L , which
contradicts the initially proposed strategy pro…le O H N L .
Then, the separating strategy pro…le O H N L cannot be sustained as a
PBE of this game either.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 12 / 33


Watson, Ch. 29 Exercise 3
Third strategy pro…le candidate to be PBE: O H O L . Let us
continue with the pooling equilibrium where both types of …rm (high
and low-quality) make a job o¤er to the worker.
The …gure below shades the branches corresponding to this strategy for
player 1.

A 2,2

NH 1 OH q
0,0
R
p
-1,0
2
2,-1
(1-p) A

0,0
NL 1 OL (1-q) R

-1,0

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 13 / 33


Watson, Ch. 29 Exercise 3

Given this strategy from the …rm, the worker’s beliefs after observing
a job o¤er must be
p 1
q= =p
p 1 + (1 p) 1

Intuitively, this implies that after observing O, the worker cannot infer
additional information about the …rm’s quality, since all …rms make
job o¤ers. (Note that this result radically di¤ers from that in the two
separating strategy pro…les described above.)

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 14 / 33


Watson, Ch. 29 Exercise 3

Given these beliefs, it is optimal for the worker to accept the job o¤er
if EU2 (A) > EU2 (R ), where

EU2 (A) = 2p + (1 p )( 1) = 3p 1

EU2 (R ) = 0 + 0
! 3p 1 = 0
1
p = for A = R
3
1
p > for A > R
3
1
p < for A < R
3

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 15 / 33


Watson, Ch. 29 Exercise 3

Hence, if p > 13 , the worker accepts the job o¤er and we can shade
branch A in the …gure.
Otherwise, the worker rejects the job o¤er and we must shade branch
R.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 16 / 33


Watson, Ch. 29 Exercise 3

Let us divide our analysis according to the value of p:


If p > 13 , the worker accepts the job o¤er. The high-quality …rm prefers
to make a job o¤er (as prescribed) since 2 > 0, while the low-quality
…rm also wants to make a job o¤er (as prescribed) since 2 > 0.
Hence, the pooling strategy pro…le O H O L can be sustained as PBE of
this game when p > 13 .

If p < 13 , the worker rejects the job o¤er. The high-quality …rm does
not want to make a job o¤er since making it yields a payo¤ of -1 (since
the o¤er is rejected) whereas not making such an o¤er yields a payo¤
of 0.
Hence, the pooling strategy pro…le O H O L cannot be sustained as PBE
of this game when p < 13 .

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 17 / 33


Watson, Ch. 29 Exercise 3
Fourth strategy pro…le candidate to be PBE: N H N L . Let us
continue with the pooling equilibrium where no type of …rm (high or
low-quality) make a job o¤er to the worker.
The …gure below shades the branches corresponding to this strategy for
player 1.

A 2,2

NH 1 OH q
0,0
R
p
-1,0
2
2,-1
(1-p) A

0,0
NL 1 OL (1-q) R

-1,0

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 18 / 33


Watson, Ch. 29 Exercise 3

Given this strategy from the …rm, the worker’s beliefs after observing
a job o¤er must be
p 0 0
q= =
p 0 + (1 p) 0 0

Hence, q can be any number in the [0, 1] interval.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 19 / 33


Watson, Ch. 29 Exercise 3

Given these beliefs, it is optimal for the worker to accept the job o¤er
if EU2 (A) > EU2 (R ), where

EU2 (A) = 2q + ( 1)(1 q)

EU2 (R ) = 0
! 2q + ( 1)(1 q) = 0
1
q= for A = R
3
1
q < for R > A
3
1
q > for R < A
3

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 20 / 33


Watson, Ch. 29 Exercise 3

Hence, if q > 13 , the worker accepts the job o¤er and we can shade
branch A in the …gure.
Otherwise, the worker rejects the job o¤er and we must shade branch
R.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 21 / 33


Watson, Ch. 29 Exercise 3

Let us divide our analysis according to the value of q:


If q > 31 , the worker accepts the job o¤er. The high-quality …rm
prefers to make a job o¤er since 2 > 0, and the low-quality …rm also
wants to make a job o¤er since 2 > 0.
Hence, the pooling strategy pro…le N H N L cannot be sustained as PBE
of this game when q > 13 .

If q < 31 , the worker rejects the job o¤er. The high-quality …rm does
not want to make a job o¤er: making it yield a payo¤ of -1 (since the
o¤er is rejected) whereas not making such an o¤er yields a payo¤ of 0.
Similarly for the low-quality …rm.
Hence, no type of …rm makes job o¤ers and the pooling strategy pro…le
N H N L can be sustained as PBE of this game when q < 13 .

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 22 / 33


Harrington, Ch. 11 Exercise 5

Consider a two-player game between a prospective employee, whom


we’ll refer to as the applicant, and an employer.
The applicant’s type is her intellect, which may be low, medium or
high, with probability 13 , 21 , and 16 , respectively.
After the applicant learns her type, she decides whether or not to go
to college. The personal cost in gaining a college degree is higher
when the applicant is less intelligent, because a less smart student has
to work harder if she is to graduate.
Assume that the cost of gaining a college degree is 2, 4, and 6 for an
applicant who is of high, moderate, and low intelligence, respectively.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 23 / 33


Harrington, Ch. 11 Exercise 5

The employer decides whether to o¤er the applicant a job as a


manager or as a clerk.
The applicant’s payo¤ to being hired as a manager is 15, while the
payo¤ to being a clerk is 10. These payo¤s are independent of the
applicant’s type.
The employer’s payo¤ from hiring someone as a clerk is 7 (and is the
same regardless of intelligence and whether or not the person has a
college degree).
If the applicant is hired as a manager, then the employer’s payo¤
increases with the applican’t intellect, from 4, to 6, to 14, depending
on whether the applicant has low, moderate, or high intellect,
respectively.
Note that the employer’s payo¤ does not depend on whether or not the
applicant has a college degree.
The extensive form of this game is shown on the next slide.
Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 24 / 33
Harrington, Ch. 11 Exercise 5

Nature

Low High

Moderate

Applicant Applicant Applicant

College No college College No college College No college

Employer Employer Employer Employer Employer Employer

Manager Manager Manager Manager Manager Manager

Clerk Clerk Clerk Clerk Clerk Clerk

Applicant 9 4 15 10 11 6 15 10 13 8 15 10

Employer 4 7 4 7 6 7 6 7 14 7 14 7

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 25 / 33


Harrington, Ch. 11 Exercise 5

Find a PBE in which students of low intellect do not go to college


and those of moderate and high intellect do.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 26 / 33


Harrington, Ch. 11 Exercise 5

The …gure on the next slide shades the branches corresponding to the
strategy pro…le we need to check, where the applicant goes to college
both when his innate ability is moderate and high, but does not go to
college when his ability is low.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 27 / 33


Harrington, Ch. 11 Exercise 5

Nature

Low High

Moderate

Applicant Applicant Applicant

College No college College No college College No college

Employer Employer Employer Employer Employer Employer

Manager Manager Manager Manager Manager Manager

Clerk Clerk Clerk Clerk Clerk Clerk

Applicant 9 4 15 10 11 6 15 10 13 8 15 10

Employer 4 7 4 7 6 7 6 7 14 7 14 7

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 28 / 33


Harrington, Ch. 11 Exercise 5

Step 1 - Employer’s beliefs:


If the student did not go to college, then he is low intellect with
probability 1
If the student did go to college, then he is low intellect with probability
zero.
1 1
2 3
µ2 moderate intellect with probability: 1 1
=
2 1+ 6 1 4

1 1
6 1
1 µ2 high intellect with probability: 1 1
=
2 1+ 6 1 4

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 29 / 33


Harrington, Ch. 11 Exercise 5

Step 2 - Firm’s best response:


If the student did not go to college, then hire him as a clerk. (She
believes the student is of low intellect, then payo¤ 7 > 4).
If the student did go to college, then the employer must compute the
expected utility from hiring the student as a manager and as a clerk, as
shown below.
µ2 1 µ2
z }| { z }| {
1 1 1 1
2 6 32
EUF (M ) = 1 1
6+ 1 1
14 = =8
2 1+ 6 1 2 1+ 6 1 4

1 1 1 1
EUF (C ) = 2 7+ 6 7=7
1 1+ 1 1 1 1+ 1 1
2 6 2 6

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 30 / 33


Harrington, Ch. 11 Exercise 5

Clearly, EUF (M) > EUF (C ), implying that if the student did go to
college, the employer hires him as a manager.
The employer’s beliefs are consistent with respect to the student not
going to college, since only when his type is low intellect does he not
go to college.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 31 / 33


Harrington, Ch. 11 Exercise 5

Step 3 - Student’s Strategy:


If of low intellect, do not go to college.
If of moderate or high intellect, go to college.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 32 / 33


Harrington, Ch. 11 Exercise 5

The next table evaluates the applicant’s incentives to deviate to a


di¤erent strategy:

No College ! Clerk College ! Manager


Low Intellect 10 > (15 6) = 9
Moderate Intellect 10 < (15 4) = 11
High Intellect 10 < (15 2) = 13

It is clear that the applicant has no incentives to deviate away from


his strategy.
Thus, this strategy pro…le can be supported as a PBE.

Félix Muñoz-García (WSU) EconS 424 - Recitation 10 April 28, 2014 33 / 33

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