Subject: Microeconomics

Note: Both questions are compulsory. Make a table or diagram wherever necessary.

Q1. Let us consider trade relations between Canada and Mexico. Assume that the leaders of the two countries believe the payoffs to alternative trade policies are as follows:

a) What is the dominant strategy for Canada? For Mexico? Explain.

b) Define Nash equilibrium. What is the Nash equilibrium for trade policy?

c) In 1993, Parliament ratified the North American Free Trade Agreement (NAFTA), in which Canada, the United States, and Mexico agreed to reduce trade barriers simultaneously. Do the perceived payoffs shown here justify this approach to trade policy?

d) Based on your understanding of the gains from trade, do you think that these payoffs actually reflect a nation's welfare under the four possible outcomes?