Consider trade relations between the U.S. and Mexico. Assume that the leaders of the two countries believe the payoffs to alternative trade policies are as follows:
U.S. Decision U.S. Decision
Low Tariffs High Tariffs
Mexico's Decision Low Tariffs (25,25) (10,30)
Mexico's Decision High Tariffs (30,10) (20,20)
a. What is the dominant strategy for the U.S.? For Mexico?
b. Define Nash equilibrium. What is the Nash equilibrium for trade policy?
c. In 1993 the U.S. Congress ratified the North American Trade Agreement, in which the U.S. and Mexico agreed to reduce trade barriers simultaneously. Do the perceived payoffs shown here justify this approach to trade policy?
d. Based on your understanding of the gains from trade, do you think that these payoffs actually reflect a nation's welfare under the four possible outcomes?