Lesson12

Name: _____________________________
Course: ____________________________
Instructor: __________________________

Date: _______

THE WORLD GAME OF ECONOMICS: LESSON 12
Focus on Game Theory & International Policy Coordination

NOTE: It is highly recommended that you read over this entire lesson before you begin.

Preliminary Discussion: The international community learned painful lessons in game theory during the global depression of the 1930's. Countries in the Great Depression assumed the worst and began to adopt dominant strategies. [Note: the dominant strategy in game theory is to choose an option that assures the least loss from all possible outcomes]. Each country raised tariff barriers against the others in a futile attempt to improve its own economic situation. Competitive currency devaluations were a common occurrence. World trade devolved to a trickle, and unemployment increased around the globe.

Having learned from the failures of beggar-thy-neighbor protectionist policies during the Great Depression, the international community set out to implement international policy coordination after World War II. The two most prominent international agencies that emerged were the International Monetary Fund (IMF) and the General Agreement on Tariffs and Trade (GATT).

Initially, the IMF established a system of fixed exchange rates. This was designed to encourage world trade by diminishing the risk associated with exchange rate fluctuations. Each member country would use its own (and borrowed) reserves to support the exchange rate in the event of a balance of payments disequilibrium. Currency devaluations were to be undertaken only as a last resort.

Fundamental weaknesses in the fixed exchange rate system forced the international community to adopt a flexible, but managed, exchange rate system in the 1970's. Today exchange rates are allowed to fluctuate within reasonable boundaries. The IMF and the leading industrialized countries attempt to coordinate central bank intervention in foreign exchange markets to prevent wide swings in currency fluctuations.

For its part, the GATT has made significant progress in lowering trade barriers around the world. It has been especially successful at reducing tariff rates. More recently, it has evolved into the World Trade Organization (WTO) and functions to resolve international trade disputes between countries.

The lesson to be learned from the historical experience is that international policy coordination is preferred to following independent strategies that attempt to make one country better off at the expense of others.

In The World Game of Economics you are the chief economic adviser to the leaders of the country of your choice. You are in charge of economic policy. You are permitted to form Free Trade Areas (FTAs) with other players. You may also work together with other players to improve the economic performance of all countries. Good luck and have fun!

1. Play The World Game of Economics to 100 points with two other students in your class. The three of you agree at the outset not to engage in trade policies (such as tariffs and currency devaluations) which adversely affect the other players' economies. You also agree to coordinate your fiscal, monetary, and trade policies in an attempt to improve each of your scores.

Play against three other countries which are computer-managed (i.e., advised by Professor N. D. Cator). Direct your trade policies against those other countries. Develop a mutually beneficial and cooperative strategy with the other human players. Essentially, you are testing international policy coordination against the beggar-thy-neighbor strategies of the computer-managed countries.

Note: If you cannot get with other students in the class, then manage the three human player countries yourself. If you do not know how to play the game, then select "Tutorial" from the main menu first. If you already know how to play, then select "New Game."

2. The three of you are the chief economic advisers to which three countries? _______________________, _____________________, and ___________________.
3. The other three computer-managed countries are ____________________________,
_______________________, and _________________________.

4. Complete the game. Print a copy of the final score and attach it to these exercises. (Note: You will turn in your three exercises together).

ANSWER QUESTIONS 5 - 9. You may work together or independently. (Circle the letter before the best single answer).

5. During the Great Depression of the 1930's, countries adopted a dominant game theory strategy; that is, they:
(a) anticipated that other countries would not raise tariff barriers against them.
(b) were certain that if they raised tariff barriers, other countries would not retaliate.
(c) attempted to dominate world trade patterns with military force.
(d) assumed that others would eventually raise barriers against them.
(e) successfully eliminated trade wars through international negotiations and cooperation.

6. An international system of fixed exchange rates is fundamentally flawed, because:
(a) It's difficult for the central banking authorities to determine the appropriate official rate of exchange between currencies.
(b) individual countries that run a balance of payments deficit must deplete their gold and currency reserves to support it.
(c) it requires an enormous amount of international reserves which must remain liquid until they are used to support a currency in crisis.
(d) it makes international policy coordination regarding fiscal, monetary, and trade policies much more difficult.
(e) All of these statements are true.

7. The International Monetary Fund (IMF) was originally established to support a system of fixed exchange rates after World War II; more recently, it has evolved to:
(a) an international agency which assists countries with problems of recession, unemployment, inflation, bank liquidity, and capital flight.
(b) the major lender to countries for development projects and programs.
(c) a powerful agency that has effectively used extortion to undermine the political autonomy of otherwise independent nations.
(d) an effective organization for settling international trade disputes.
(e) All of these statements are true.

8. The history of the World Trade Organization (WTO), formerly known as the General Agreement on Tariffs and Trade (GATT), demonstrates that:
(a) it is virtually impossible for countries to cooperate, because the forces of nationalism are too popular and powerful.
(b) the world will soon evolve to a unified political system with a global common market and a single currency to be used as a medium of exchange by everyone.
(c) in spite of somewhat freer trade, the forces of national autonomy versus international cooperation will continue to struggle for the foreseeable future.
(d) most nations consistently adopt autarchy, self-sufficiency, and independence over strategies which promote freer international trade.
(e) unfortunately, free trade has proven to be the main cause of depression, inflation, and unemployment in the world.

9. Coordinating international economic policy is difficult, because:
(a) no one really wants to cooperate.
(b) each country has its own unique problems.
(c) economic theories are wrong more often than right.
(d) the dominant strategy is always the best strategy for individual countries.
(e) All of these statements are true.

End of Lesson 12

Note: At the instructor's discretion, you will each receive _____ possible points for this exercise.

Instructor's Option: At the discretion of the instructor, you will each receive additional points according to the following formula: Add together the total of your three scores at the end of the game: _____. Now add together the scores of the three computer-managed countries: _____. Subtract the score of the computer-managed countries from the total of your three countries. Enter that number here: _____. Divide this number by 3. Enter that number here: _____. If this number is negative, then you will each get zero extra points. . If the number is between 0 and 10, you will each receive that many extra points. If the number is 10 or more, you will each get 10 extra points. (Show Computations).

Winning Strategy Hints: Winning strategy involves anticipating the Economic Indicator, playing your policy options efficiently, coordinating your range of policies, and using trade policy to prevent one country from getting too far ahead. Consider your opponents’ options and try to anticipate their trade policies. Keep in mind that countries tend to use trade restrictions, tariffs, and currency devaluations when they have high unemployment. Be careful not to get caught having too many inappropriate and useless options. Discard policy gridlock and foreign policy conflict options as frequently as possible. [You don’t want to be trapped in a Depression like the United States in the 1930s or caught like Germany in Hyperinflation in the early 1920s]. Study the probabilities that are provided in the instructions. That will help you plan your strategy.

Global interdependency is portrayed both indirectly and directly in The World Game of Economics. Indirectly, when the Economic Indicator changes direction for one country, it changes direction for all the other countries. This demonstrates how economic recessions and recoveries are internationally contagious. When one country’s economy expands (or contracts), it begins to import more (or less) from other countries. Directly, one country’s trade policy affects another country. The two countries move in opposite directions. For example, when one country depreciates its currency vis-à-vis another country’s currency, exports increase in the former and decrease in the latter.

When planning your trade policy strategy, recall the other countries’ monetary policies. Note the direction of the Economic Indicator and consider which countries are leading in the game score. Try to move those countries away from the center at the same time that you improve your own country’s position.

When forming a Free Trade Area (FTA) or common market with other countries, direct trade policy toward non-members. That is, you will have a common external trade policy. Tariffs should not be increased against members of your common market. If your common market evolves to a monetary union, then coordinate your fiscal and monetary polices as well as your external trade policy.