Question

4. Problems and Applications Q4

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 shown in the following payoff matrix:

		United States’ Decision
		Low Tariffs	High Tariffs
Mexico’s Decision	Low Tariffs	$28 billion, $28 billion	$20 billion, $30 billion
	High Tariffs	$30 billion, $20 billion	$25 billion, $25 billion

The dominant strategy for the United States is to always choose 9 LOR or HIGH )  tariffs. The dominant strategy for Mexico is to always choose ( LOW or HIGH )  tariffs.

True or False: The Nash equilibrium outcome for trade policy is for the United States to have low tariffs and Mexico to have high tarriffs.

True

False

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.

True or False: Given the trade strategy decisions in the table, the United States is worse off and Mexico is better off with this new trade policy.

True

False

Based on your understanding of the gains from trade (discussed in Chapters 3 and 9), which of the following statements accurately characterize how well the payoffs indicated for the four possible outcomes actually reflect a nation’s welfare? Check all that apply.

______The payoffs in the upper right and lower left corners of the matrix do not reflect a nation’s welfare because tariffs hurt overall total surplus, so both countries’ welfare should decline regardless of who charges the high and low tariffs.

______The payoffs in the upper right and lower left corners of the matrix reflect a nation’s welfare because the nation with lower tariffs is better off, since that nation is more open to trade.

______The payoffs in the upper left and lower right corners of the matrix reflect a nation’s welfare because they show that trade is beneficial and tariffs are a barrier to trade.

Answer 1