Question

Consider trade relations between the United States and Mexico. Assume that the leaders of the two countries believe the payoffs to alternative trade policies are as follows:

a. What is the dominant strategy for the United States? For Mexico? Explain.
b. Define Nash equilibrium. What is the Nash equilibrium for trade policy?
c. In 1993 the U.S. Congress ratified the North American Free Trade Agreement, in which the United States and Mexico agreed to reduce trade barriers simultaneously. Do the perceived payoffs shown here justify this approach to trade policy? Explain.
d. Based on your understanding of the gains from trade (discussed in Chapters 3 and 9), do you think that these payoffs actually reflect a nation’s welfare under the four possible outcomes?

Answer 1

A.
The dominant syrategy for both mexico and US is high tariff.

b.
NE is defined as both palyers utilizing the best response method to make their decisions and it the final outcome as a result of this. In this case NE is (high tariff, high tariff)

c.
In this case, the payoffs our higher than the payoffs of NE. In a sence, the NAFTA agreement will allow the two countires to colude and both have low tariffs increasing both of their payoffs from 20 to 25

d.
These do not actually reflect nations welfare under the four possible outcomes, only a prediction as to what outcome will be chosen. Although the tariffs are higher or lower, this does not take into consideration any dead weight loss.


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