Suppose there is a budget deficit. It can be reduced by cutting military spending, by cutting welfare programs, or by cutting both. The Democrats have to decide whether to support cuts in welfare programs. The Republicans have to decide whether to support cuts in military spending.

The possible outcomes are represented in the following table:

The table presents payoffs to each party under the various outcomes. Think of a payoff as a measure of happiness for a given party under a given outcome. If Democrats vote for welfare cuts, and Republicans vote against cuts in military spending, the Republicans receive a payoff of 3, and the Democrats receive a payoff of -2 .

a. If the Republicans decide to cut military spending, what is the best response of the Democrats? Given this response, what is the payoff for the Republicans?

b. If the Republicans decide not to cut military spending, what is the best response of the Democrats? Given this response, what is the payoff for the Republicans?

c. What will the Republicans do? What will the Democrats do? Will the budget deficit be reduced? Why or why not? (A game with a payoff structure like the one in this problem, and that produces the outcome you have just described, is known as a prisoner's dilemma.) Is there a way to improve the outcome?

Transcribed Image Text:

Welfare Cuts Yes No Defense Yes (R 1, D -2) (R -2, D=3) Cuts No (R = 3, D -2) = (R -1, D -1)