Country A’s leader has to decide whether to sign a free-trade agreement with country B or with country C. Due to the domestic political situation, she can sign only one free-trade agreement. Suppose A’s annual revenue from a free-trade agreement with B is $800M and A’s annual revenue from a free-trade agreement with C is $400M. The probability that B will agree to sign the agreement is 0.3 and the probability that C will agree to sign the agreement is 0.75. Assume also that the leader prefers an agreement to no agreement and so does not want to sign an agreement that will be rejected by the other side. Assuming that A’s leader is risk-neutral, what choice should she make?
a. A should sign a free-trade agreement with C because the probability that C will agree is higher than the probability that B will agree.
b. A should sign a free-trade agreement with B because the revenue is higher than a revenue from a free-trade agreement with C.
c. A should sign a free-trade agreement with C because the expected utility of an agreement with C is higher than the expected utility of an agreement with B.
d. A should sign a free-trade agreement with B because the expected utility of an agreement with C is higher than the expected utility of an agreement with C.
Ans: c
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