Scenario: Contiguous states often use tax policy to attract residents, firms, and economic activity. These "tax competitions" between states can be modeled with game theory. Suppose New Jersey currently has a state sales tax of 7 percent and Pennsylvania has a state sales tax of 6 percent. The game shown below models the effect of a reduction in each state's sales tax rate to 3 percent on each state's sales tax revenue. Assume the motivation of each state is to maximize tax revenue. The first number in a cell is the payoff to New Jersey; the second number is the payoff to Pennsylvania.

(Source: John Greenwald, "A No-Win War Between the States," Time, April 8, 1996, 44-45.
-Refer to the scenario above.Is there a set of payoffs that is superior to the payoffs realized at the dominant strategy equilibrium?
A) No.
B) Yes, New Jersey maintains its sales tax rate, realizing $18 million in tax revenues, and Pennsylvania lowers its sales tax rate, realizing $22 million in tax revenues.
C) Yes, New Jersey maintains its sales tax rate, realizing $24 million in tax revenues, and Pennsylvania also maintains its sales tax rate, realizing $20 million in tax revenues.
D) Yes, New Jersey lowers its sales tax rate, realizing $26 million in tax revenues, and Pennsylvania maintains its sales tax rate, realizing $14 million in tax revenues.

Question

Scenario: Contiguous states often use tax policy to attract residents, firms, and economic activity. These "tax competitions" between states can be modeled with game theory. Suppose New Jersey currently has a state sales tax of 7 percent and Pennsylvania has a state sales tax of 6 percent. The game shown below models the effect of a reduction in each state's sales tax rate to 3 percent on each state's sales tax revenue. Assume the motivation of each state is to maximize tax revenue. The first number in a cell is the payoff to New Jersey; the second number is the payoff to Pennsylvania.
  
(Source: John Greenwald, "A No-Win War Between the States," Time, April 8, 1996, 44-45.
-Refer to the scenario above.Is there a set of payoffs that is superior to the payoffs realized at the dominant strategy equilibrium?
A) No. 
B) Yes, New Jersey maintains its sales tax rate, realizing $18 million in tax revenues, and Pennsylvania lowers its sales tax rate, realizing $22 million in tax revenues. 
C) Yes, New Jersey maintains its sales tax rate, realizing $24 million in tax revenues, and Pennsylvania also maintains its sales tax rate, realizing $20 million in tax revenues. 
D) Yes, New Jersey lowers its sales tax rate, realizing $26 million in tax revenues, and Pennsylvania maintains its sales tax rate, realizing $14 million in tax revenues.

Quizplus · Accepted Answer

The correct answer is C because it describes a scenario where both states maintain their sales tax rates, resulting in a higher combined total of tax revenues ($44 million) compared to any unilateral decision to lower the tax rate by either state. This suggests a cooperative outcome that is superior to the competitive equilibrium, assuming the dominant strategy leads to both states lowering their rates for lesser combined revenue.

Scenario: Contiguous States Often Use Tax Policy to Attract Residents