Consider the following strategic situation in which the United States and the European Union are engaged in trade negotiations. Both countries must decide whether to reduce their tariffs or impose new tariffs. The best outcome for both countries is for them to impose new tariffs and for the other side to reduce tariffs; they could then export more easily to the other country and they would obtain increased revenue from the new tariffs. The worst outcome for both countries is for them to reduce tariffs and for the other country to increase tariffs; they would lose jobs as a result of reduced exports and the other country would benefit from their lower tariffs. Of the remaining two outcomes, both countries prefer the outcome in which they reduce tariffs to the one in which they both impose new tariffs. If both countries reduce their tariffs, then each country can benefit from increased free trade. If both countries impose new tariffs, there is a trade war in which each country sees a decline in trade and a loss of jobs. Based on this story, the preference ordering for the EU over the four possible outcomes is:
• Impose; Reduce > Reduce; Reduce > Impose; Impose > Reduce; Impose.
And the preference ordering for the United States is:
• Reduce; Impose > Reduce; Reduce > Impose; Impose > Impose; Reduce,
where the EU’s action is given first, the United States’ action is given second, and “>” means “is strictly preferred to.”
1. Using the ordinal preferences (4, 3, 2, 1) to capture these preference orderings, fill in the empty payoff matrix. Based on the preference orderings in the Free Trade Game, what is this sort of game more generally called?
a. prisoner's dilemma
b. pure coordination game
c. chicken
d. asymmetric coordination game
2. what are the nash equilibrium of this game?
a. reduce tariffs; reduce tariffs
b. reduce tariffs; impose tariffs
c. impose tariffs; reduce tariffs
d. impose tariffs; impose tariffs
3. Does the EU have a dominant strategy in the Free Trade Game?
a) Yes, reduce tariffs.
b) Yes, impose new tariffs.
Does the United States have a dominant strategy in the Free Trade Game?
a) Yes, reduce tariffs.
b) Yes, impose new tariffs.
What is (are) the expected outcome (outcomes) of the game?
a) Increased free trade.
b) Lost jobs in EU, increased revenue for United States.
c) Increased revenue in EU, lost jobs in United States.
d) Trade war.
