Reciprocal dumping

All the theories we have seen so far are in fact general equilibrium models.

Useful to understand the effect of trade openness on the production, employment, wages and welfare structures. But they omit firms strategic behaviors. and many industries are in fact oligopolies where firms acknowledge their impact the market.

Reciprocal dumping

In the late 1970s, a new theory of international trade was born, inspired by industrial economics.

James Brander, Barbara Spencer, Paul Krugman. Provide a framework to analyse international competition within an oligopoly. It is a more micro-economic analysis, in partial equilibrium (only focused on a given industry) wages and demand are exogeneous. Here, we consider a duopoly.

Reciprocal dumping

Two countries. One firm in each country. They produce exactly similar goods (different from Krugman)= one price on each market. After openness, each firm is going to sell to the foreign market, after paying a transport cost

Reciprocal dumping

Each exporting firm has to pay a transport cost for each unit Firms compete in terms of quantity (Cournot competition)

Cost function: Inverse demand function:

Each firm maximizes its profit on each market. On the foreign market:

Reciprocal dumping
Firm 1 chooses Q1 (how much to export): P

aQ1 bQ12 bQ1Q2 cQ1 Q1

Ibid firm 2

Firms reaction functions = best possible reaction to the competitor

Reciprocal dumping

Reciprocal dumping
Equilibrium is defined by the intersection of reaction functions (both firms max. profits given the strategy of the other firm: Nash equilibrium):

The higher the transport cost, the larger the market share of the domestic firm. If > (a c)/2 then Q1 = 0. The equilibrium price on the foreign market is therefore:

The higher the transport cost, the higher the price

Reciprocal dumping

Conclusion 1: Type of trade

1.

Even if the domestic firm has to pay an extra cost, it can sell on the foreign market. The foreign firm is also going to sell on the domestic market We get perfect intra-industry trade. In order to sell at a competitive price on foreign markets, firms have to reduce their margins Firms have different unit margins for different markets.
= reciprocal dumping.

2.

3.

The price increases transport cost.

less

than

proportionately

with

the

Trade versus autarky with reciprocal dumping

In autarky, firm 2 has a monopoly over its market. The output is:

After openess, the overall quantity offered is: QT>Qta if Q1>0 (<(a-c)/2) The autarky price is:

In autarky, lower quantities & higher price than if Q1>0

Reciprocal dumping
Conclusion 2: Gain to trade?
1.

Trade fosters competition: quantities increase, prices go down, consumers are the winners pro-competitive effect. Profits go down Firms lose. Trade implies transport costs for identical goods: efficiency loss Openness can lead to the exclusion of one of the two firms if it is less productive there is a new monopoly on the foreign market but the monopolist is more efficient Gain of rationalization

2. 3.

4.

5.