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?