Question 3: Is optimal tariff rate optimal?

(10 points)

In this question we continue our discussion in Question 2 but consider a slightly different setting. Here we assume that (i) Mr. Malfoy owns 100% of Hogwarts Bezoar Tech and the other two gentlemen owns nothing; (ii) Mr. Malfoy himself does not consume Bezoar! Thus weonly have two consumers, Mr. Potter and Mr. Weasley.

(a) What is the preferred tariff rate for each individual now? Suppose the government follows the median voter rule, what tariff rate will the government pick? Suppose Mr. Malfoy is filthy rich that he could buy off the government, will the tariff rate change then? (4 points. )

(b) We have not considered possible responses from the foreign country. Suppose the foreign country could set positive tariff rates on imports from Hogwarts as well. We may use a PD (prisoner dilemma game) to understand this strategic situation:

Hogwarts\Foreign countryFree tradePositive tariffFree trade(10, 10)(-10,20)Positive tariff(20, -10)(-5,-5)

Note: This table represents the same information as Table 10-3.

According to the table, what do you think Hogwarts will choose if the foreign country chooses "free trade"? What will Hogwarts choose if the foreign country chooses "positive tariff"? Therefore, what do you think will be two countries' choices in the equilibrium? Is it a desirable result? (4 points)

(c) The situation in (b) represents a single period of time. In practice, how can countries avoid the (Positive Tariff, Positive Tariff) result over a multi-period game? (2 points)