Problem: Consider a union in an on-going relationship with a firm. There are two periods. The union has a default contract, negotiated previously that gives it a surplus of 10, while the firm gets zero from the default contract. In each period there is a potential innovation. In the first period, if the two parties agree to innovate there is a surplus of 16 generated, of which the union will get their default payoff of 10, plus any additional compensation provided by the firm. In the second period, if innovation did not previously occur, the two parties can innovate if they both agree; if they do the union gets its default and the firm gets (v - 10). If, on the other hand, innovation did occur in period 1 the union has lost its old default contract. In this case, the two parties bargain with one another and each gets ½ of v. (v is the total surplus generated from innovation in the final period.)

Required:

Question 1: Draw the time line of the game.

Question 2: Is innovation efficient?