Jim Whitney   March 16, 2011

Exercise: Trade policy negotiations

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

 

Before class:

Step 1: Study the gains from trade table and be sure you understand it. You should figure out answers to the following questions:

    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?
Step 2: Think about being a policymaker in each country. Brainstorm some specific intervention policies which will work in your favor by raising your terms of trade. In other words, think of policies which either:
    RAISE the price you fetch from your trading partner for your exports or
    LOWER the price you pay to your trading partner for your imports.
(Work on your own on this part--it might give you an edge during class.)
During class: I will assign you to several teams of US/Ch pairs to carry out one or more rounds of global trade.
1. Set up a record sheet on a full-size sheet of paper. Record:
        Your team (USA1, USA2, USA3, Ch1, Ch2, Ch3)
        Your team members
2. Your goal: to maximize your own country's gains from trade
3. For each round played: deliberate for 5 minutes with your fellow citizens, and then write down on your record sheet the round number and your policy choice:
        --free trade, or
        --intervention (indicating a specific intervention policy).