ePack: Principles of Microeconomics 6th Edition by Gregory Mankiw

Exercise 4

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?