Question

Consider the trade relations between the United States and China. Assume the leaders of the countries believe the payoffs to alternative trade policies are as follows. If both countries impose low tariffs, then both countries will gain $60 billion. If both countries impose high tariffs, then both countries will gain $40 billion. If one country imposes high tariffs, the country that has high imposed tariffs will gain $50 billion and the country that imposes low tariffs will receive $20 billion.

Draw the payout matrix describing the payouts given the trade choices by the two countries.

Does the United States have a dominant strategy?

Does China have a dominant strategy?

Using the dominant strategy concept explain your answers. Based on this information, is there a Nash equilibrium for trade policy between the United States and China?

Answer 1

Based on the given information in the question , we get the following payoff matrix as shown below:

		CHINA
		Low tariff	High Tariff
UNITED STATES	Low Tariff	$60 billion, $60 billion	$20 billion , $50 billion
	High tariff	$50 billion , $20 billion	$40 billion, $40 billion

When China chooses Low tariff , then US has more pay off in choosing Low tariff i.e $60 billion.

And When China chooses High tariff , then US has more payoff in choosing High tariff i.e $40 billion.

This implies that United states does not have any dominant strategy.

Similarly, When US chooses Low tariff , then China has more pay off in choosing Low tariff i.e $60 billion.

And When US chooses High tariff , then China has more pay off in choosing High tariff i.e $40 billion.

This implies China also does not have any dominant strategy.

By seeing both countries best responses, Nash equilibria are : (LOW tariff , LOW tariff ) and (HIGH tariff , HIGH tariff).