Problem
Fred is on a business trip and is eating at a restaurant that he has never visited before and will not ever visit again.
Assume his server, Daniel, earn $10 an hour. Assume that the cost to Daniel of providing good service is equal to $10 and the cost of providing poor service is equal to $0.
Assume that if Daniel provides poor service that Fred will not provide a tip and the value of the meal to Fred will be equal to $5
Assume that if Daniel provides good service that the value of the meal to Fred is equal to $45. Fred will either give a $20 tip or give no tip.
Set up a decision tree where Daniel decide whether to provide poor or good service and, if he provide good service, Fred must decide to give a zero tip or a $20 tip.
a) Set up a decision tree and find the equilibrium.
b) What is the relevance of Fred only visiting the restaurant one time?
c) In the real world, do you think Daniel and Fred would behave in the way our decision tree predicts they would behave? Why or why not?