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Consider the following situation. An individual may decide to pay taxes of $1200 or evade them. Assume that if the individual evades taxes and is audited, he pays a fine of $350, in addition to back taxes. The IRS can choose whether or not to audit the individual. An audit costs the IRS $200 to conduct.
a. Set up the strategic form (payoff table), with the IRS as player 1 and the individual as player 2.
b. Identify the Nash equilibrium (if one exists). If none exists, find the mixed-strategy Nash equilibrium.
c. Draw the game tree for the game in which the IRS pre-commits to a probability of an audit, and then the individual makes the decision to pay or evade. For what range of probabilities will the individual choose to pay? To evade?
Explain how are you morally justifying your decision. Remember to use professional e-mail etiquette when composing your e-mail.
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