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Trade Bargaining & Enforcement

This article examines the benefits of free trade and explores why governments sometimes pursue protectionist policies. Possible reasons include incorrect beliefs about protectionism, concerns for those negatively impacted by trade, and the potential short-term benefits of protectionism.

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Trade Bargaining & Enforcement

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  1. Trade Bargaining & Enforcement International Political Economy Prof. Tyson Roberts

  2. Puzzle • Comparative advantage: free trade good for all nations, in aggregate • Then why do governments pursue protectionist policies?

  3. Some possible answers • Government leaders have “Wrong ideas” and believe protectionism helps • Mercantilism, etc. • Protectionism may hurt in short-run but help in long-run (Lecture 8) • Government leaders concerned more about losers from trade than winners from trade (Today and Lectures 6-7)

  4. Review of Comparative Advantage

  5. The basic Ricardo model • Two countries • Two products • One factor of production (e.g., labor)

  6. Home • 1200 labor units • 30 labor units to make iPods • Can produce up to 40 iPods • 5 labor units to make pair of running shoes • Can produce up to 240 pairs of shoes • Opportunity cost ≈ Price • “Price” of 1 iPod is 6 pairs of shoes • “Price” of 1 pair shoes is 1/6 iPod

  7. Production possibility frontierHome 40 iPods Slope = -1/6 240 Shoes

  8. Foreign • 720 labor units • 12 labor units to make iPods • Can produce up to 60 iPods • 4 labor units to make pair of running shoes • Can produce up to 180 pairs of shoes • Opportunity cost ≈ Price • “Price” of 1 iPod is 3 pairs of shoes (12 hours/4 hours) • “Price” of 1 pair of shoes is 1/3 iPod (4 hours/12 hours)

  9. Production possibility frontierFrontier 60 iPods Slope = -1/3 180 Shoes

  10. Another example • Now assume that demand curves in Home & Foreign are such that the international price of shoes per iPod is 5 (and price of iPods per shoes is 1/5) • What is the new PPF for Home and Frontier after trade?

  11. Production possibility frontier: Home with tradeHome can make 240 shoes and buy 240/5 = 48 iPods 48 40 iPods 240 Shoes

  12. Production possibility frontier: Foreign with tradeForeign can make 60 iPods and buy 60 x 5 = 300 pairs shoes 60 BUT Home cannot make 300 shoes! iPods 180 300 Shoes

  13. Home can only make 240 pairs shoes 48 40 iPods 240 Shoes

  14. Production possibility frontier: Foreign with tradeSo Foreign can make 48 iPods and trade for 48 x 5 = 240 ShoesThen Foreign can take the remaining 720 – (48 x 12) = 144hours and make 144/4 = 36 Shoes 60 Foreign can buy 240 Shoes and make 36 Shoes Total possible shoes = 276 iPods 180 276 240 300 Shoes

  15. Return to the Price = iPod for 4 shoes scenarioHome can trade 240 shoes for 60 iPods 60 40 iPods 240 Shoes

  16. Foreign can trade 60 iPods for 240 shoes 60 iPods 180 240 Shoes

  17. If International Price = 4 shoes/iPod Which outcomes are Pareto optimal?

  18. If International Price = 4 shoes/iPod Which outcomes are Pareto optimal? Offer, Offer

  19. Some Game Theory Terminology • Pareto Improvement: At least one player is better off and no players are worse off • Pareto Efficient/Optimal: No Pareto Improvements available • Pareto Inefficient/Sub-Optimal: Pareto Improvements are available Trade enables Pareto Improvements for Pareto Sub-Optimal Situations Vilfredo Pareto

  20. If International Price = 4 shoes/iPod Which outcomes are Pareto optimal? Offer, Offer Is this a Nash Equilibrium?

  21. Solving simultaneous games in game theory • Left actor chooses row, top actor chooses column • Payoff for left actor is on left, payoff for top actor is on right of each cell • Actors get payoff from cell determined by joint choices • Simultaneous: Each actor does not know what other actor will choose

  22. Nash Equilibrium • No player has anything to gain by changing his own strategy unilaterally

  23. Best Home strategy if Foreign offers? Which outcomes are Pareto optimal? What are the equilbria?

  24. Best Home strategy if Foreign offers?Offer Which outcomes are Pareto optimal? What are the equilbria?

  25. Best Home strategy if doesn’t offer? Which outcomes are Pareto optimal? What are the equilbria?

  26. Best Home strategy if doesn’t offer?Offer or Consume Which outcomes are Pareto optimal? What are the equilbria?

  27. Best Foreign strategy if Home offers? Which outcomes are Pareto optimal? What are the equilbria?

  28. Best Foreign strategy if Home offers?Offer Which outcomes are Pareto optimal? What are the equilbria?

  29. Best Foreign strategy if Home offers? Which outcomes are Pareto optimal? What are the equilbria?

  30. Best Foreign strategy if Home offers?Offer or consume Which outcomes are Pareto optimal? What are the equilbria?

  31. Nash Equilibrium: No player has anything to gain by changing his own strategy unilaterally What are the equilbria if international price = 4 shoes/iPod? ANSWER: Offer, Offer Consume, Consume

  32. If Price is outside the range of 3 and 6 shoes per iPod (e.g., 8 shoes per iPod), no trade will occur What are the equilbria if international price = 8 shoes/iPod? ANSWER: Consume, Consume

  33. But there is an opportunity for Pareto improvementsForeign can offer a lower price for iPods than 6 shoes Starting endowment

  34. Summary • Comparative advantage enables mutual gains from trade • If no mutual gains are available, countries will not trade • Therefore, trade is always Pareto efficient • Assumes voluntary, fully informed decisions • Ignores long-term effects, externalities, etc. • Prices will adjust until no Pareto improvements are available (invisible hand)

  35. If Robinson lives alone, he does everything himself

  36. If a second person arrives, one can specialize in coconuts and the other can specialize in fish, and they can benefit from trade

  37. If each actor is “fully informed,” trade results in a Pareto Improvement

  38. However, each actor may have an incentive to cheat

  39. Cheat, Cheat is the Nash EquilibriumStay true, Stay true would be Pareto Improvement

  40. Institutions to prevent cheating • Long-term relationships based on reciprocity and trust

  41. Suppose Robinson and Friday can trade repeatedlyWhat is/are the Nash Equilibrium/a?

  42. The prospect of repeated interactions converts cooperation into a Nash Equilibrium(But Cheat, Cheat also remains a Nash Equilibrium!) Which Nash Equilibrium is Pareto Efficient?

  43. The prospect of repeated interactions converts cooperation into a Nash Equilibrium(But Cheat, Cheat also remains a Nash Equilibrium!) Which Nash Equilibrium is Pareto Efficient? Stay true, Stay true

  44. If the coconut seller gets a bad fish, he knows who sold it to him. He can refuse to trade again until he is compensated

  45. As the distance and complexity of trade increases, potential for trade benefits increase, but cheating is more difficult to monitor

  46. Similarly, if there are a small number of farmers agreeing to cut back on water use of a limited water source … • The action of each individual would make a large difference, so each has a greater incentive to comply • The small number of actors makes monitoring compliance easier • => Cooperation more likely than the case with thousands of farmers

  47. Necessary conditions for cooperation • Repeated interaction • Reciprocity strategy (e.g., tit-for-tat) • If you are fair to me today, I’ll be fair to you tomorrow • Repeated pay off of 1s = 1 + 1 + 1 + …. • If you cheat me today, I will cheat you tomorrow • You might get 2 today, but you’ll get 0 every day after that

  48. Necessary conditions for cooperation • Repeated interaction • Reciprocity strategy (e.g., tit-for-tat) • Sufficient value of future payoffs • If value of future payoffs is too low, then cheat will remain the dominant strategy • For example, if the discount factor is 1/10, then the sum of repeated payoffs will be less than the payoff of cheating once now

  49. What is/are the Nash Equilibrium/a?

  50. What is/are the Nash Equilibrium/a?Cheat, Cheat

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