11_oligopoly_slides.pdf

Oligopoly and TradeNotes for Oxford M.Phil. International Trade

J. Peter Neary

University of Oxford

November 26, 2009

J.P. Neary (University of Oxford) Oligopoly and Trade November 26, 2009 1 / 11

Oligopoly and TradePlan of Lectures

Motivation

Duopoly in Partial Equilibrium

Trade Costs: "Reciprocal Dumping"

Oligopoly in General Equilibrium

Extensions


Motivation

So far: "Imperfect competition" = Monopolistic Competition

BUT: Only one form; closest to perfect competitionShares many properties:

1 Atomistic rms, ex ante identical;2 No strategic behaviour.

Empirical implausible:

Increasing evidence that large rms account for bulk of trade;and that they are dierent from smaller ones;see: Bernard, Jensen, Redding and Schott (JEP 2007).

Industrial organisation has "Two faces":1 Size distribution of rms under perfect or monopolistic competition2 Oligopoly: Small-group interaction.

Seems worth exploring oligopoly in trade too; for short run at least.


Duopoly in Partial Equilibrium

Brander (JIE 1981):Two countries, fully symmetric, one rm in each, partial equilibrium:

FirmsHome Foreign

Markets Home x yForeign x y

Assume goods are perfect substitutes (not essential).Autarky: each rm is a domestic monopoly.

Positive eects of moving to free trade:Assume markets are segmented, though this is not essential.Assume rms engage in Cournot competition.Each rm faces competition at home, and sells in others market.So: "cross-hauling" or "intra-industry trade in identical commodities"!Remarkable: no comparative advantage or diversity motive for trade.So: a new and distinct theory of trade.However: not obvious that in itself it is quantitatively important.Some evidence: Bernhofen (JIE 1999), Friberg-Ganslandt (JIE 2006).


Duopoly in Partial EquilibriumAutarky versus Free Trade: Figure

x

y

B

H

H'

F

F'

Cournot competition:Home reaction function (best-response function): HH 0.Foreign reaction function: FF 0.Autarky equilibrium: Zero imports (y = 0): F 0.Free-trade equilibrium: B .


Trade Costs: "Reciprocal Dumping"

Now, suppose that trade is costly:

As long as trade costs are non-prohibitive, cross-hauling occurs.Markets are identical, so home rm charges the same in each;BUT: This means it must absorb some of the transport cost;Hence its prot margin is lower on export sales: it is "dumping";Since both rms are doing this, there is "reciprocal dumping".

Welfare eects of changes in transport costs are not simple:

Home welfare is the sum of consumer surplus and home rm prots;Consumer surplus: Falls with t, since home prices rise.Prots in home market rise with t: reduced competition.Prots in foreign market fall with t: reduced export opportunities.These moves in opposite directions imply that prots fall for movesaway from both autarky and free trade.


Trade Costs: "Reciprocal Dumping"Components of Home Welfare: Figure

B

tt0

p

*p

Figure: Components of Home Welfare as a Function of Transport Costs


Trade Costs: "Reciprocal Dumping"The Linear Example

Linear demands; constant marginal costs.p = a bX X = x + y p = a bY Y = x + ypi = (p c)x + (p c t)xHome Firms FOCs:H : p c bx = 0 ! a c 2bx by = 0H : p c t bx = 0 ! a c t 2bx by = 0

Equilibrium in home market:2 11 2

bxby

=

a c

a c t

! x = a2c+c +t3b y = a2c2t+c3b

Symmetrically: x = a2c2t+c 3b y = a2c +c+t3b

Autarky: y = 0 ! tA = 12 (a 2c + c) ! xA = ac2bProts on Home Sales:

pi = bx2 ! dpidt = 2bx dxdt = 23 x > 0 ! d2pidt2 =

23dxdt =

29b > 0

i.e., " in t raises home sales linearly, and raises prots on home sales bymore the higher they are already (i.e., the higher is t):So, prots on home sales are convex in t.


Trade Costs: "Reciprocal Dumping"The Linear Example II

Prots on Exports:

pi = b (x)2 x = a2c2t+c 3b! dpidt = 2bx dx

dt = 43 x < 0 ! d

2pidt2 = 43 dx

dt =

89b > 0

i.e., " in t lowers export sales linearly, but lowers prots on these salesby less the lower they are already (i.e., the higher is t):prots on foreign sales are convex in t.

Total Prots (in symmetric equilibrium):d (pi+pi)

dt =23 x 43 x8 0 when x = 0 (i.e., t = tA)= 0 when x = 2x (i.e., t = tM = a2c+c 5 )


Trade Costs: "Reciprocal Dumping"The Linear Example III: Intuition

Intuition:(i) Starting from free trade:

Exports are harmed more by an increase in own costs than home salesare helped by an equal rise in rivals costs;Hence total sales and prots fall for a small increase in t at free trade.

(ii) Starting from autarky:Exports are helped more by a fall in own costs than home sales areharmed by an equal fall in rivals costs;Hence total sales rise for a small reduction in t at autarky, andcontinue to rise monotonically as t falls.However, this does not translate into a monotonic rise in prots:Exports are initially zero, so the rise in sales has a negligible eect onprots in the export market,whereas home sales are initially maximal, so the fall in sales has arst-order eect on home-market prots;Hence, overall prots fall for a small reduction in t at autarky.


Trade Costs: "Reciprocal Dumping"The Story So Far

Recap on the Brander model:

Strategic interaction an independent explanation for trade;Competition eects a new source of gains from trade;Highlights the threats and opportunities of trade for rms:i.e., more competition at home, increased markets abroad.

Yet: Not really a full theory of trade.

[Krugman: "There are two and a half theories of trade"!]Why: Mainly, because not embedded in general equilibriumSo: We need to do this: Put Ol igopoly into General Equilibrium:"GOLE"


Oligopoly and TradePlan of Lectures

MotivationDuopoly in Partial EquilibriumAutarky versus Free Trade: FigureTrade Costs: "Reciprocal Dumping"Components of Home Welfare: FigureThe Linear ExampleThe Linear Example IIThe Linear Example III: IntuitionThe Story So Far

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