Q4. Consider trade relations between the United States and Mexico. Assume that t

Question

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 as follow

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.

Explanation / Answer

a)US is better off by choosing high,(30>25) and (20>10),irrespective of whether Mexico chooses high or low,So US has dominant strategy to choose high.

Mexico is better off by choosing high,(30>25) and (20>10),irrespective of whether US chooses high or low,So Mexico has dominant strategy to choose high.

b)Agents interact to choose their best action given action of other agent.It is called nash equilibrium.Nash equilibrium here is to have high tariffs for both (20,20).

c)If they reduce trade barriers simultaneously,they both choose low tariffs,and both get (25,25).They are better off.So it justifies this approach to trade policy.

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