(e) Let \( p2 = 1 \). Suppose \( p1 \) changes from \( 1/2 \) to \( 2 \). Find the equivalent variation and the compensating variation.

2. (9 %) Consider two players in a game: Legislator (L) and the Judiciary (J). The Legislator and the Judiciary negotiate a bill $B$ to be executed from a policy space $\mathcal{B} = [0,10]$, where $B0 = 0$ is the status quo. Legislator's favorite policy is $BL^* = 9$, and Judiciary's favorite policy is $B_J^* = 3$. The game has 2 stages and proceeds as follows: Stage 1: The Legislator chooses a bill $B_L \in [0,10]$. Stage 2: After seeing $BL$, the Judiciary can choose to pass or reject the bill. If the bill is passed, the executed bill will be $B = BL$. If the bill is rejected, the society goes back to the status quo, $B = B_0 = 0$. Define player $i$'s payoff as $\pii = |Bi^* - B|$. Assume that the Judiciary will not reject the bill if rejecting the bill is indifferent to her. (a) Under the Subgame Perfect Nash Equilibrium, what is the equilibrium bill passed, \( B_{SPNE} \)?

(b) Fix \( B{L}^{} = 9 \), and make \( B{J}^{} \) variable. Express the passed bill under the SPNE as the function of the Judiciary's preference \( B(B_{J}^{}) \). Make sure you have discussed all possibilities \( B_{J}^{} \in [0,10] \).

3. (24 %) Consider a duopoly market that consists of two firms, OpenAI and Google. The competition proceeds as follows: Stage 1: Each firm simultaneously determines its own R&D input level, $x_i$. Stage 2: Knowing the R&D input level of each other, each firm simultaneously determines its own output level, $q_i$. Each firm has the following cost function: $$Ci(qi, xi, xj) = (70 - (xi + xj))qi + 2xi^2,$$ where $xj$ is the R&D level the other firm chooses. Let the inverse demand function of the market be $P = 100 - \frac{1}{3}Q$, where $Q = qO + q_G$. (a) Consider the Cournot duopoly equilibrium. Given \( x{O}, x{G} \) determined, find the equilibrium output chosen by each firm in Stage 2.

(b) Following (a), express the profit functions as functions of \( x{O}, x{G} \).

(c) Following (b), find each firm's best response function of R&D input level in Stage 1.

(d) Following (c), find each firm's equilibrium level of R&D input.

(e) Find the social welfare under this scenario, where the social welfare is defined as the sum of the consumer surplus and the firms' profits.

Now, suppose the two firms agree to collude in Stage 1 but continue to compete in a Cournot manner in Stage 2. That is, the two firms will collude with the R&D input level in Stage 1, and then individually decide the output levels in Stage 2. The two firms agree to coordinate R&D levels to maximize total joint profit. (f) Find the optimal level of each firm's R&D input under collusion. Compare your answer with (d). Intuitively explain the difference.

(g) Find the social welfare under this scenario.

4. (20 %) Consider a firm whose CEO's compensation equals a fraction λ of the firm's operating profit. The CEO is risk-averse and has utility U(W)=ln (W), where W is the compensation. The firm's production function is y=θ√k, where k≥0 is the capital input and θ is a random productivity shock with Probability(θ=2)=1/2, Probability(θ=1)=1/2. (a) The output price is \( p \) and the unit cost of capital is \( r > 0 \). Please derive the CEO's optimal choice of capital \( k \). (10%)

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