Modeling the US-China Trade Conflict: A Utility Theory Approach

This paper models the US-China trade conflict initiated in 2018 and attempts to analyze the (optimal) strategic choices of the United States and China. In contrast to the existing literature on the topic, we employ the expected utility theory and examine the conflict mathematically. In both perfect information and incomplete information games, we show that expected net gains diminish as the utility of winning increases because of the costs incurred during the struggle. We find that the best response function exists for China but not for the US during the conflict. The results of our models indicate that the less the US pressures China to change its existing trade practices, the higher the US expected net gains. China’s best choice is to maintain the status quo, and any further aggression in its policy and behavior, such as artificially adjust exchange rates and slash imports from the US, will aggravate the situation. The theoretical framework designed in this paper can be also used to examine the bilateral technological frictions.