Jim Whitney | Economics 131 |
Basic situation:
Two large-country trading partners:
United States (US): Capital-abundant
China (Ch): Labor-abundant
Two products:
Aircraft (A): Capital-intensive
Textiles (T): Labor-intensive
Large countries can potentially increase their gains from trade by
adopting policies which improve their terms of trade. Gains from trade
depend on policy choices as follows:
|
US choice | ||
Free trade | Intervention | ||
China's
choice |
Free trade | US: 54
China: 54 |
US: 72
China: 24 |
Intervention | US: 24
China: 72 |
US: 30
China: 30 |
What policy will maximize China's gains from trade if China expects the U.S. to choose free trade? What about if China expects the U.S. to choose intervention? Do you get the same answer or different answers in the two cases? (Repeat these questions for the U.S.) |
Can you predict what box the two countries will end up in if they don't get a chance to negotiate with each other? If not, why not? If so, which box is it, and does your box maximize the global gains from trade? |