Question 1

The standard strategic trade policy story treats protectionism between countries as a Prisoner's dilemma. In the case of two similar sized economies with similar reliances on trade, this treatment seems reasonable. In the case of two dissimilarly sized economies, this treatment may not be entirely accurate...or at least, the two counties are not similarly disadvantaged by a trade war.

The United States' economy is roughly twenty times as large as the Canadian economy, in terms of Gross Domestic Product (GDP). Consider that the United States and Canada are considering whether to impose tariffs on each other's exports. The resulting payoffs from each possible outcome (relative to the "no tariffs" baseline) are given as:

• If both countries impose a tariff, Canada receives a payoff of -$50 billion, and the United States receives a payoff of -$5 billion
• If the United States imposes a tariff, but Canada does not impose a tariff, Canada receives a payoff of -$45 billion, and the United States receives a payoff of $40 billion.
• If Canada imposes a tariff, but the United States does not impose a tariff, Canada receives a payoff of -$5 billion, and the United States receives a payoff of -$10 billion.
• If neither country imposes a tariff, the payoff to both countries is $0.

Identify the Nash Equilibrium of this game. Explain your answer carefully.