We can think of U.S. and Japanese trade policies as a prisoners’ dilemma. The two countries are considering policies to open or close their import markets. The payoff matrix is shown below.

	Japan
Open	Close
U.S.	Open	10, 10	5, 5
Close	-100, 5	1, 1

1. Assume that each country knows the payoff matrix and believes that the other country will act in its own interest. Does either country have a dominant strategy? What will be the equilibrium policies if each country acts rationally to maximize its welfare?

2. Now assume that Japan is not certain that the United States will behave rationally. In particular, Japan is concerned that U.S. politicians may want to penalize Japan even if that does not maximize U.S. welfare. How might this concern affect Japan’s choice of strategy? How might this change the equilibrium?

The table shows that both countries have a dominant strategy of opting to open their import markets.

When the U.S. opts for Open, Japan will also choose Open and earn a payoff of 10 units (greater than 5 units obtained by choosing Close). When the U.S. opts for Close, Japan will choose Open and earn a payoff of 5 units (greater than 1 unit obtained at opting for Close).

Similarly, the U.S. will also opt for Open and earn higher payoffs than opting for Close, regardless of Japan’s decision.

Both countries have a simultaneous dominant strategy of opening their import markets.

Thus, the equilibrium point of welfare-maximization will be obtained at (Open, Open) with the payoff (10, 10).

If the U.S. politicians do not behave rationally and choose to penalize Japan at the cost of not maximizing U.S. welfare, they will decide to close their import markets.

As Japan has a dominant strategy of opting for Open, irrespective of the U.S.’s decision, the new equilibrium point will be attained at (Open, Close) with the payoffs being (5, 5).

Thus, when U.S. politicians do not behave rationally and penalize Japan, the payoff for both countries will be lowered, and the new equilibrium will be attained at (Open, Close) with payoffs (5, 5).