Assume the two players are a Local Firm and a foreign Oil Company. Both would like to develop an oilfield, from which gross revenues would be 7. The fixed costs of sinking the oil rigs to start producing are 3. Variable cost is 2. The remaining profit of 2 will be divided between the two players (assuming oil production commences). The Local Firm proposes an initial fee of f, between 0 and 2. The Oil Company can either Decline the proposal, in which case both players get a payoff of 0, or can Accept and pay the fixed costs of sinking the oil rigs. Because legal contracts are not enforceable in the local country, the Local Firm can then either Abide by the contract or Renegotiate the contract. If the Local Firm Renegotiates, they can increase the fee to the Oil Company up to r. The Oil Company can then either decide to Extract the oil (paying r instead of f) or Pull Out, suffering the fixed cost of 3 and the Local Firm getting 0. The extensive form of the game is illustrated below: f, 2-f 0,0 r, 2-r Decline Abide Extract Local Firm L.F. O.C. Oil Co Accept/ Sink Rigs Renegotiate Pull Out Proposal 0, -3 a. Assume that we have got to the last stage of the game where the Local Firm decides to Renegotiate. What level of r would the Local Firm ask for? b. Going one step back in the game, given the r that you found in part a, would the Local Firm want to Abide or Renegotiate if the game reaches this stage of the game? Why? c. Given what the Local Firm will do from parts a and b, will the Oil Company Accept or Decline any initial offer of f (between 0 and 2) from the Local Firm? Why? d. Given what you have found in parts a, b, and c, is the outcome of the game efficient or not? Is the Local Firm helped or hurt by being able to renegotiate the contract? What kind of policy would help bring about higher payoffs for both players?