Question

Japanese officials are considering a new tariff on imported pork products from the United States in an attempt to reduce Japan’s reliance on U.S. pork. Due to political pressure, the U. S. International Trade Representative’s (ITR) office is also considering a new tariff on imported steel from Japan. Officials in both Japan and the United States must assess the social welfare ramifications of their tariff decisions. Reports from a reliable think tank indicate the following: If neither country imposes a new tariff, social welfare in Japan’s economy will remain at \(10billion and social welfare in the United States will remain at \)50billion. If both countries impose a new tariff, welfare in the United States declines \( 49.1 billion and welfare in Japan declines by \) 8.9billion. If Japan does not impose a tariff but the United States does, projected welfare in Japan is \(billion while welfare in the United States is \)52.5billion. Finally, if the United States does not impose a tariff but Japan does, welfare is projected at \(48.2billion in the United States and \) 11.4billion in Japan. Determine the Nash equilibrium outcome when policy makers in the two countries simultaneously but independently make tariff decisions in a myopic (one-shot) setting. Is it possible for the two countries to improve their social welfare by “agreeing” to different strategies? Explain.

Short answer

There is the option that both countries collude and can reach an agreement and establish an equilibrium of No tariffs for both countries, in which the welfare of each one will be greater than in the Nash equilibrium$(50,10)$

Step-by-step solution

Observing the matrix

The welfare obtained as a result of trade between the United States and Japan can be modified by the tariffs imposed by each country. In the case of Japan, it would apply tariffs to the import of pork from the United States, while the US measure would impose tariffs on the import of steel from Japan.

Therefore, the decisions of Japan and the United States will be to impose or not import tariffs. The welfare resulting from the combinations of these measures can be observed in the following matrix.

The dominant strategy of the United States will be to impose a Tariff since regardless of Japan's choice, it will obtain a greater welfare than by not applying the Tariff.

On the Japanese side, its dominant strategy will also be to impose a Tariff, since no matter what the US chooses, its well-being will be greater.

Therefore, the only Nash equilibrium present in this one-shot simultaneous game will be for both countries to impose tariffs (tariff, tariff) obtaining a welfare of ($49.1,9.5$)

Explaining the two countries improving their social welfare

There is the option that both countries collude and can reach an agreement and establish an equilibrium of No tariffs for both countries, in which the welfare of each one will be greater than in the Nash equilibrium$(50,10)$

However, this is only possible if there is certainty and reliable information that the game is infinitely repetitive and that the present value of the cost of cheating exceeds the one-time benefit of cheating, or what is the same when the interest rate is low enough to maintain a cooperative strategy.