WTO and the deterrence effect

Suppose there are two countries, Home and Foreign. Both countries are choosing whether to promote free trade or to impose a tariff (protection). The payoff matrix is shown in the table below. Please answer the following questions.

a) What is Home's payoff when Foreign chooses free trade while Home chooses protection?

b) Suppose both countries are choosing their strategies independently. What is Home's best strategy when Foreign chooses free trade? What is Home's best strategy when Foreign chooses protection? Which strategies are Home and Foreign most likely to choose? Explain.

c) What is the role of trade agreements in maintaining free trade?

d) WTO allows partners to retaliate by raising tariffs if one country is found to have violated WTO rules. This question asks you to consider why such a mechanism can help to maintain free trade. Suppose both countries have chosen free trade for a while. In one year, Home suddenly switched its policy and raised its tariff, but Foreign didn't have time to respond and kept import tariff zero. In the next year, WTO ruled that Home violated WTO rules and allowed Foreign to retaliate. What was the Home's total payoff in these two years? Had Home not deviated from free trade, what would its payoff have been in these two years? Explain why retaliation helps to maintain free trade.

e) Suppose one group of Home producers form a strong political alliance. Therefore, protection provides additional political gain in Home, and the payoff to protection increases from 4 to 6 when Foreign chooses free trade (see the payoff matrix below). Show that, in order to prevent Home from raising tariff, Foreign must retaliate for at least two years after Home deviates from free trade.