Studies in Games and Incentives

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This ambitious project extends game theory and applies game theory to the study of durable goods monopoly and income tax auditing. More specifically, the project examines game theoretic equilibria that are rationalizable strategies in a game derived from the original game by adding a strategy for a player which allows that player to get the equilibrium value of the original game for sure. Earlier work has shown that these equilibria can be used to unify different work on signalling games. The goal of this project is to extend the results to more general games. A model of dynamic monopoly with entry of new consumers is characterized. This model seems to have stationary equilibria in which the seller loses the ability to price discriminate as the time between offers shrinks, and nonstationary equilibria in which the seller maintains some monopoly power. The project develops a three-level model of tax setting and enforcement. The government sets tax rates, penalties for noncompliance, and a budget for the auditor. The auditor determines which reports to audit. Taxpayers determine how much income to report. The project characterizes the linear tax and auditing budget that maximizes a social welfare function. The resulting characterization is used to find conditions under which it is optimal for the auditor to be under budgeted. This exciting project makes important contributions to game theory, industrial organization and public finance. The research in game theory develops and generalizes a new way of examining the robustness of the results obtained from games by adding strategies with fixed outcomes to the original game. The work in industrial organization has already obtained surprising evidence of the persistence of price discrimination that has implications for government policy. The extensions should improve our understanding of the ability of durable good monopolists to price discriminate via periodic sales. The third part finds evidence that the middle-income taxpayers are over-audited by the IRS. The hierarchical model of income tax auditing used for this part of the project should provide other novel insights in public finance.