Consider trade relations between Australia and New Zealand. Assume that the leaders of the two countries believe the pay-offs to alternative trade policies are as follows:

a What is the dominant strategy for Australia? For New Zealand? Explain.

b Define Nash equilibrium. What is the Nash equilibrium for trade policy?

c Under the Closer Economic Relations agreement, Australia and New Zealand both agreed to allow free trade in goods and services between the two countries. Do the perceived pay-offs as shown here justify this move to a bilateral free trade policy?

d Based on your understanding of the gains from trade (discussed in Chapters 3 and 9), do you think that these pay-offs actually reflect a nation’s welfare under the four possible outcomes?