Country A and Country B have to decide whether to impose a tariff against the other. They payoff matrix below gives the payoff of each country for all possible cases (whether they impose the tariff or choose free trade). Each row in the matrix corresponds to Country A's decision (strategy) and each column Country B's decision (strategy). The payoff of Country A is stated first in each quadrant of the matrix.. The payoffs equal the gain or loss of each country, compared to free trade.

 

                                                          Country B

 

                                           Free Trade                Tariff

 

                   Free Trade       0, 0                        -60,  20

 

                                                            Country A

                   Tariff             20, - 60                      -40, -40

i) Find the Nash Equilibrium of this tariff game; explain how you were able to identify the equilibrium.  What is the payoff of each country in the Nash Equilibrium? 

i) Assume that the two countries have chosen the policies indicated by the Nash Equilibrium.  Does either country perceive a motivation to unilaterally (by itself) to change its policy decision? Why or why not?

iii) Based on the Nash Equilibrium payoffs, can you find an argument in favor of a multilateral  change in their trade policy?  Would any multilateral change offer both countries a gain? Explain.