(b) A firm and its union bargain as follows. First the union makes a wage demand, w. The

firm observes w and chooses whether or not to accept it. If the firm accepts, then it

chooses a level of employment, L. If it does not accept, then L is zero. The firm's payoff

is F = 6L^1/2 wL, and the union's payoff is u = (w B) L, where B> 0. (Assume that

if the firm is indifferent between accepting and not-accepting, it will choose to accept.)

Derive the unique subgame perfect equilibrium outcome. (6 marks)

(c) Two countries, A and B, independently select trade policies. If they both select low

tariffs, they each get a payoff of 5. If A selects high tariffs and B selects low tariffs, A

gets 6 and B gets 3, while if A selects low tariffs and B selects high tariffs, A gets 3

and B gets 6. If they both select high tariffs, they both get 4.

Derive conditions on the period discount factor for which an equilibrium featuring low

tariffs in every period can be sustained under infinite repetition by the threat of

indefinite reversion to high tariffs in response to any deviation from low tariffs (grim

trigger strategy). Explain. (6 marks)