International Business Chapter 9 Home Demand Curve And The Import Quota Because Not All Consumer Demands

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9 Import Tariffs and Quotas Under Imperfect Competition

Notes to Instructor

Chapter Summary

This chapter is much like the previous Chapter 8, except now we will drop the

assumption of perfectly competitive markets and examine once again the impact of

gain.

Then we turn to an example of a Foreign monopolist who is a discriminating monopolist

engaging in dumping products into the home market. And, we will find that antidumping

duties have the potential to result in losses for the home country.

Finally, we consider the case of government policies of “infant-industry” protection,

Comments

This chapter offers a number of interesting applications that link theory and real–world

events. In addition, the questions at the end of the chapter refer students to the

Lecture Notes

Introduction

Though most economists agree that tariffs and quotas usually reduce general economic

when the foreign exporting firm is a monopolist. Contrary to the situation in which the

home firm is a monopoly, the importing country may experience a terms-of-trade gain

similar to the “large country under perfect competition case” by imposing a tariff on the

sole foreign producer.

A country may protect its domestic firms by imposing a tariff on a foreign competitor

1 Tariffs and Quotas with Home Monopoly

We begin by assuming that the Home firm is the only producer selling a homogeneous

good. We will see that tariffs and quotas are nonequivalent in imperfect competition.

No–Trade Equilibrium

The Home demand curve, D, and the monopolist’s marginal cost curve, MC, are

Comparison with Perfect Competition Suppose Home consisted of many firms selling

the same product and that the industry marginal cost equals the monopoly marginal cost

Free–Trade Equilibrium

Suppose that Home is a small country. Under free trade, the monopolist may not charge a

price higher than PW because consumers can meet their demand via imports at the given

Comparison with Perfect Competition

By continuing to assume that the competitive firms face the same cost conditions as a

Home monopoly, we see that with free trade this small country will consume D1 at the

Effect of a Home Tariff

Suppose Home imposes a tariff in the amount of t on imports. The tariff raises the Home

price to PW + t, which becomes the highest price the monopolist can charge for the

product. The higher price corresponds to an upward shift of the marginal revenue curve

Comparison with Perfect Competition With the tariff, the monopolist continues to set

equilibrium quantity and price equal to that of a perfectly competitive industry with a

Home Loss Due to the Tariff The impact of the import tariff on Home welfare is the

same with the monopoly and perfect competition, as summarized by the following:

Effect of a Home Quota

Now let’s replace the tariff with a quota that limits imports to the exact amount that

would enter Home under the import tax (i.e., M2), as illustrated in Figure 9-4. Because no

more than M2 can be imported from abroad, the effective demand faced by the

under the quota than the tariff, S3 < S2. The reason this result is possible is that the quota

creates a “sheltered” market for the Home firm, which allows the monopolist to exercise

Home Loss Due to the Quota We see that under imperfectly competitive markets, tariffs

and quotas have different effects on Home prices. Namely, the price faced by Home

APPLICATION

U.S. Imports of Japanese Automobiles

We previously mentioned that during the 1980s the government in Japan limited the

quantity of Japanese automobiles exported to the United States. We now examine in

Undeterred by the failure to obtain Section 201 protection, several members of Congress

from states where the auto industry was active introduced a bill to restrict import

competition, particularly from Japan. Shortly before the bill’s scheduled revision by the

Senate Finance Committee, the Japanese government announced that it would

“voluntarily” impose limits on the sales of automobiles in the U.S. market. The quota was

Price and Quality of Imports As shown in Figure 9-5, under the VER, the average price

of imported Japanese cars increased by about $2,900 between 1980 and 1985. A third of

the price increase ($1,100) was due to quota rents earned by Japanese producers. With the

Quota Rents The rent earned by the Japanese producers is found by multiplying the

quota rents of $1,100 per car by the imports of about 2 million cars. The total estimated

The Japanese were limited on the number of cars each firm could import, but not the

Price of U.S. Cars In addition to the price increase for Japanese cars due to the VER, the

price of European cars sold in the U.S. market also rose as a result of lessened

The GATT and WTO Contrary to an import quota, the restraint of Japanese automobile

exports did not violate Article XI of the GATT, because the VER was enforced by Japan

rather than the United States. Consequently, the use of VERs increased in popularity in

2 Tariffs with Foreign Monopoly

We just analyzed the case for a monopolist in a small home country. Now we will move

to the case in which the Foreign exporting firm is a monopoly and Home is still a small

Foreign Monopoly

We will extend the previous example by assuming that the Foreign firm is a monopolist

in its local and export markets, meaning that Home’s demand is satisfied entirely by the

Free–Trade Equilibrium Without barriers to trade, the Foreign monopolist exports X1,

for P1, where the Home marginal revenue, MR, equals marginal costs, MC*, at point A.

Effect of a Tariff on Home Price With the fixed tariff in the amount of t dollars, the

marginal cost of exporting to the Home market increases to MC* + t, as shown in Figure

9-7. Given the higher marginal costs, the Foreign firm decreases exports to X2. This

In situations in which the marginal revenue curve is steeper than the Home country’s

demand curve, the importing country may experience a terms-of-trade gain because the

increase in the import price from P1 to P2 is less than the amount of the tariff, t. To

prevent the quantity exported from falling below X2, the Foreign firm absorbs part of the

Effect of the Tariff on Home Welfare To determine the effect of the tariff on Home

welfare, note that the increase in the import price reduces consumer surplus by the area (c

+ d), as illustrated in Figure 9-7. Home producer surplus is unaffected, as there are no

Fall in Home consumer surplus: −(c + d)

where Home is better off with the tariff if the terms-of-trade gain denoted by area e is

APPLICATION

Import Tariffs on Japanese Trucks

Initially, compact trucks imported from Japan mainly consisted of cab/chassis, which

were classified as “parts of trucks,” requiring some final assembly in the United States

A study of the increased tariff on compact trucks provides evidence in support of the

theory presented above. Namely, the results of the study suggest that the Japanese

producers passed along 12% of the tariff to U.S. consumer prices. The remaining 9% was

absorbed by the exporters. Due to the reclassification of the imported compact trucks

from Japan, the United States experienced a terms-of-trade gain as predicted, where the

An important point should be made here in our studies of gains and losses from trade

policies. Specifically, we have a second example of a case whereby a country may stand

to gain by implementing a strategic trade policy. In Chapter 8, we learned that a large

home country may experience a terms-of-trade gain, albeit at the expense of its trading

H E A D L I N E S

The Chickens Have Come Home to Roost

This section argues that the current troubles of the big three U.S. automobile producers

may be linked to the 25% tariff on lightweight trucks, which was born out of an “accident

of history.” With the tariff, the U.S. auto industry focused on the sales of trucks where it

now had a more “competitive” advantage. But, this required that consumers demanded

3 Dumping

Given their market power, firms engage in dumping by taking advantage of their ability

to charge different prices across countries to increase their profits. A firm is considered to

be dumping if it sells a product at less than its average costs of production, or more

antidumping duties.

In this section, we address why firms engage in dumping. Is it really always a case of

dumping at unprofitable prices in order to drive out competition or increase market

share? Why are these firms selling at below average costs or setting foreign prices below

their local prices and engaging in price discrimination? Is pricing strategy unprofitable?

Discriminating Monopoly We examine how a firm may find it profitable to price below

the market value or the average cost of production. We begin by assuming that the

Foreign firm is a monopolist in its local market but has competition in the Home market.

Moreover, possibly due to a tariff or high transport costs between the markets, arbitrage

Equilibrium Condition To maximize profit, the Foreign firm produces Q1 at point B,

where marginal costs equal the export marginal revenue, MR. Of the amount produced,

The Profitability of Dumping Furthermore, Figure 9-8 also shows that the Foreign

monopoly is dumping when defined by the export price set below the average cost of