Consider the following interaction between two entrepreneurs (players 1 and 2) w

Question

Consider the following interaction between two entrepreneurs (players 1 and 2) who are working on a joint project, and a venture capitalist (player 3) who is a potential investor in the project. First, player 1 decides whether to devote high or low effort to preliminary work on the project. Player 2 observes this choice and then decides whether to devote high or low effort himself. They then make a presentation to the venture capitalist, who can observe which, if any, of the entrepreneurs devoted high effort to the project, and decides whether or not to invest. The payoffs are as follows. Each entrepreneur gets a payment of 5 if the venture capitalist invests and 0 otherwise. In addition, choosing high effort costs an entrepreneur 1, while choosing low effort is free. Investing costs the venture capitalist 2, but if he invests he gains 3 for each entrepreneur who chose high effort. If the venture capitalist does not invest, his payoff is 0. Draw the game tree corresponding to this game and find its equilibrium outcome by solving backwards.

Explanation / Answer

player 1

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