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Question 3 Spain and Italy are also members of the European Union. Their membership in the union prevents them from imposing tariffs on each

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Question 3 Spain and Italy are also members of the European Union. Their membership in the union prevents them from imposing tariffs on each other's goods and services. This question will explore how the penalties for breaking EU trade rules might alter countries' behavior. Spain and Italy can independently choose to impose a tariff on imports form the other country. The normal form game below depicts the payoffs associated with each possible outcome of this interaction. Importantly, the values below do not take account of any possible penalties for breaking EU trade rules. Spain Don't Impose Tariff Impose Tariff Impose Tariff 163 billion 5:42 billion 10 billion Italy Don't Impose Tariff E60 billion Ebilion Part (i): Identify the Nash Equilibrium of the game. Part (ii): Suppose that the European Union imposes a fine on any country that imposes a tariff. Not surprisingly, sufficiently small fines will not affect the counties' decisions. What is the maximum fine such that the Nash Equilibrium you identified in Part (i) is still the Nash Equilibrium of this game? Part (iii): Suppose that the European Union imposes a fine on any country that imposes a tariff. There is a range of values for this fine such that Spain does not impose a tariff, but Italy does. What is this range? Part (iv): Suppose that the European Union imposes a fine on any country that imposes a tariff. There is a minimum fine above which neither country imposes a tariff. What is this threshold value?

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