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:

Low tariffs

New Zealand's decision

High tariffs

Australia's decision

Low tariffs

High tariffs

Australia gains

* Australia gains

New

$10 billion New

$20 billion

Zealand

Zealand

gains $10 billion

gains $2 billion

Australia gains

Australia gains

$2 billion

• New
• New $4 billion

Zealand

Zealand

gains $20 billion

gains $4 billion

a What is the dominant strategy for Australia? For New Zealand? Explain. b Define Nash equilibrium. What is the Nash equilibrium for trade policy?

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?