AGEC 652 Lecture 35 and 36

Transcription

1 AGEC 652 Lecture 35 and 36 Strategic Trade Theory - Imperfect Competition in World Markets I. What is Strategic Trade Theory? A. Not a single coherent theory but rather a collection of theories and literature that does not necessarily converge but which consider the effects of imperfect competition and international market power on international trade. B. Some of the more prevalent theories and concepts: 1. Countervailing Power literature (popularized by Galbraith 1950s) - Premise: foreign monopoly must be confronted by domestic monopoly 2. Market Conduct, Performance, Structure (CSP) literature (Mason 1939,1949; Bain 1951, 1956) - Industrial Organization literature which rejects neoclassical models of perfect competition and monopoly in favor of a more direct approach emphasizing oligopoly theory. - Empirical studies relating measures of market performance (profit, price markup over cost, export propensity, etc.) to firm concentration, size, and other structural variables. 3. New Strategic Trade Theory (Spencer and Brander 1983, 1985) - Governments can intervene strategically with taxes, subsidies, or other measures to give firms operating in imperfectly competitive markets a long-term advantage over foreign firms at a high benefit-cost ratio. 4. New Empirical Industrial Organization Literature (Perloff 1991) - Related to the CSP literature but recognizes that structural variables like R&D, innovation, advertising, firm size, concentration, must be considered along with market performance. 5. Modern Neoclassical Economics (Henderson and Frank 1990; Porter 1990) - Role of Government is to supply public goods, including competitive environment and absence of trade distortions. - Emphasizes policies favorable to world benefit-cost ratios and deadweight losses.

2 II. Gains from Trade (Importing Country): Imperfect Competition vs. Perfect Competition S or MC P m P p d e a b c P W MR DD Q m Q c change in CS + change in PS net change Perfect Competition Imperfect Comp. Conclusion: With competitive pricing and output, the gain from trade is only area c but when a domestic monopoly in autarky (small country) must compete with imports, the gain from trade is larger.

3 III. Imperfect Competition in the Domestic Market A. Effect of Trade on Monopoly (Small Country) MC P m P w MR DD Q m Q c

4 III. Imperfect Competition in the Domestic Market (cont d) B. Import Tariff with Domestic Monopoly (Small Country) MC P m P p P w + T m P w + T m P w DD Q m Q m Q Q c Q c

5 III. Imperfect Competition in the Domestic Market (cont d) C. Non-equivalence of Quota and Tariff Under Imperfect Competition D facing monopolist MC P m P m a b P w P w + T m D Q m Q m Q Q c Q c Given tariff and quota with the same import restriction. With quota, the price linkage between the domestic and world market is severed. The P w + T m curve is no longer the MR curve facing the monopolist. The demand facing the monopolist is not D because imports satisfy some domestic demand. Demand facing monopolist is D with a new, lower MR curve. Monopolist produces Q m. Consumption is Q c = Q m + imports (Q c Q m ). Conclusion: Given a tariff and quota that imply the same initial reduction in imports, the quota results in a higher domestic price and lower levels of both production and consumption than the tariff given a domestic monopoly.

6 IV. Imperfect Competition in International Markets A. Single Producer-Exporter or State Export Monopoly 1. Effects of An Optimal Export Tax D x S x ES(MC) P w a c g b d f h j e P f P d ED MR ed To maximize profit, monopolist exporter equates MR ed =MC (ES) in the international market and sets price at P f. The optimal export quantity is OQ w. 2. At that point, g (c + d) is maximized. Why? 3. Even if g is transferred to producers, the government would have to tax consumers and transfer that to producers just to keep them even. Conclusions: (1) a monopolist exporting country maximizes national welfare at the expense of producers so individual producers would oppose use of market power with optimal tax and (2) a single firm monopolist gains from such a tax and would favor an optimal tax if revenue accrues to exporter. Q

7 2. Calculation of Optimal Tax Rate Assume that Q = excess demand and P = domestic price Remember that TR = PQ and MR = dtr/dq a. Then MR = dtr/dq = (PdQ + QdP)/dQ = P(dQ/dQ) + Q(dP/dQ) = P + Q(dP/dQ)(P/P) = P + (Q/P)(dP/dQ)P = P + P(1/ε) where ε = (dq/dp)p/q (elasticity of excess demand) = P(1 + 1/ε) b. At the optimal export level P = (1 + t)mr where t is the optimal tax rate. c. Then substituting: P = (1+t)[P(1 + 1/ε)] P = P(1 + t)(1 + 1/ε) 1 = 1 + t + 1/ε + t/ε 0 = t(1 + 1/ε) + 1/ε t = -(1/ε)/(1 + 1/ε) = -1/(ε + 1) Thus, the higher the elasticity of excess demand, the lower the optimal tax rate. The lower (i.e., more inelastic) the elasticity of excess demand, the higher the optimal tax rate. Conclusion:.

8 B. Price Leadership Cartel If the exporter is dominant with a fringe of other exporters who follow its lead: (1) Free rider problem - underselling by small exporters makes optimal tax policy difficult. (2) P f > P w creates an incentive for supply expansion in completing export countries and provides incentives from a cartel. (3) Particularly of interest in commodity markets where exporter concentration ratios are high (e.g., wheat, coarse grains, soybeans, coffee, tea, etc.) C. Government Cartel Analytically the same as a single exporter monopolist except that the ES curve is now the sum of the individual exporter s ES curves. Operational rules would be necessary. (1) The lower price must be passed back to both domestic producers and consumers. (2) All exporters must sell to importers at the higher price. (3) If any payments from monopoly profits are transferred to producers, measures must be taken to avoid an expansion of production. There is a strong incentive for countries to raise P d slightly and to lower P f slightly to sell additional output (again, the free rider problem). Penalties may be necessary to force compliance. An additional problem for agricultural commodity cartel: All countries would have an incentive to increase production which would exert downward pressure on world trade prices.

9 D. Producer Marketing Board (Single monopolist exporting country with many individual producers) S x = MC x ES P 0 P w a b c ED DD MR T D T 0 Q d Q 0 Q p 0 Q w 1. For a monopolist exporting country with many producers, an optimal tax has one big drawback producers lose! 2. Alternative: Producers band together to form a producer marketing board and extract monopoly rent from both domestic and foreign consumers. 3. Producers maximize profits by producing at Q 0 where MR T = MC. 4. Producers extract a from domestic consumers and b from foreign consumers but lose c in producer surplus. a + b is likely > c. 5. Foreign and domestic consumers are worse off and the government gains no revenues. 6. Major problem: If producers successfully achieve the higher price, there will be incentive to produce 0Q p which is >0Q 0. Thus, some method of controlling market supply is necessary such as marketing or production quotas.

10 E. Producer Cartel If there were a few countries that produced and exported a commodity, the producers in those countries could form a cartel would face the same problems of price maintenance, detection of cheating, enforcement of sanctions, etc. as a government cartel. They would have the additional problem of allocating production quotas among member countries. F. Exporter Price Discrimination 1. Exporter monopolist or export cartel might find it more profitable to charge different prices to markets, i.e., price discriminate. Conditions for price discrimination to work: (1), (2), and (3). 2. Assume 4 international markets where a monopolist exporter could sell (figure 6-9 in McCalla and Josling reading): (1) DCs support price above world price level with levies or quotas (2) CPEs buy through state agencies or buy only sporadically (3) MICs no foreign exchange constraints (4) LDCs bound by foreign exchange constraints (unitary demand elasticity) 3. Question: Would the exporter be better off by charging prices to the DCs equal to their support prices, charge all that the markets in CPEs will bear, and sell to LDCs at their low domestic price levels (price discriminate)?

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12 F. Exporter Price Discrimination (cont d) 4. Optimum level of output is 0Q A allocated such that the MRs are equal in each market. The price is set in each country accordingly. This is the rent-maximizing solution for the cartel. How much is allocated to LDCs? 5. Note that the weighted average price P* p > P FT. Some supply control is necessary to reduce the incentive to overproduce. 6. LDCs offer an alternative to supply management. If excess at P* p was exported to LDCs at the price that = MR (i.e., P LY ), this transfer or food aid would be a rational alternative. If the direct and implicit cost of the necessary supply control program to restrain output to 0Q A exceeded ABCD, then they would choose that supply disposal alternative. G. Conclusions regarding exploitation of international market power: 1. Producers in cartels are better off with 0Q A and P* p relative to free trade. 2. World prices higher but no longer uniform. 3. Importers are exploited relative to their own interface with world markets. 4. Countries that isolate their markets pay the highest price sort of a Free Rider Justice. Final Comments on International Market Power Analysis 1. The more countries that fix or guarantee internal prices, the greater the potential gains from the exercise of international market power. 2. The steeper the excess demand function facing the exporter, the greater the disparity between free market and cartel prices necessitating greater supply control measures (in the case of producer cartels). Government cartels benefit consumers and other users. 3. The analysis ignores retaliation and dynamics of game playing.