3. Ann owns a business that brings an annual income of 600K (High income) in a good year and 200K (Low income) in a bad year. Ann has to pay 25% of her annual income as income tax to the government if her income is strictly above 200K (i.e. her tax liability is zero if her income is 200K or below). Government cannot observe Ann's annual income (i.e. whether it has been a good year or not); but, believes that the probability that it is a good year is 0.5. In this game, first Nature moves and determines whether it is a good year or not. After observing that it is a good year (and knowing her annual income is High), Ann declares High income (600K) or Low income (200K) to the government. If she declares High income, she pays 150K as income tax (and ends up with 450K). If Ann has a bad year and low income, she will always declare Low income to the government. After observing Ann's statement, that is High or Low income, but without observing her actual income, the government decides whether to Audit or Not audit Ann's business. After seeing a High income statement, the government will always find it profitable to Not Audit. However, after seeing a Low income statement, the government will choose whether to audit or not. Auditing is costly for both of the parties and the cost of audit is 100K for both. If the government chooses to audit Ann after seeing a Low income statement and finds out it has indeed been a bad year, Ann pays 0 tax but both incur the cost of audit (Ann ends up with 100K). If the government finds out 3. Ann owns a business that brings an annual income of 600K (High income) in a good year and 200K (Low income) in a bad year. Ann has to pay 25% of her annual income as income tax to the government if her income is strictly above 200K (i.e. her tax liability is zero if her income is 200K or below). Government cannot observe Ann's annual income (i.e. whether it has been a good year or not); but, believes that the probability that it is a good year is 0.5. In this game, first Nature moves and determines whether it is a good year or not. After observing that it is a good year (and knowing her annual income is High), Ann declares High income (600K) or Low income (200K) to the government. If she declares High income, she pays 150K as income tax (and ends up with 450K). If Ann has a bad year and low income, she will always declare Low income to the government. After observing Ann's statement, that is High or Low income, but without observing her actual income, the government decides whether to Audit or Not audit Ann's business. After seeing a High income statement, the government will always find it profitable to Not Audit. However, after seeing a Low income statement, the government will choose whether to audit or not. Auditing is costly for both of the parties and the cost of audit is 100K for both. If the government chooses to audit Ann after seeing a Low income statement and finds out it has indeed been a bad year, Ann pays 0 tax but both incur the cost of audit (Ann ends up with 100K). If the government finds out