Commercial Policy and Imperfectly Competitive Markets

The Politics of Protection in the U.S.: Main Mechanisms

• Protection is obtained through (1) direct action by the president (e.g., VERs) or (2) four types of legal procedures– Countervailing duties

– Antidumping duties

– Escape clause relief

– Section 301 retaliation

KEY CLAIMS TO PROTECTION

PARTICULARLY FOR U.S. IMPORT SUBSTITUTE INDUSTRIES

The Politics of Protection in the U.S.

• In the case of these four legal procedures, a firm or industry petitions the federal government to initiate an investigation into foreign country or foreign firm practices

• Take them one by one

Countervailing Duties

• Countervailing duty: a tariff that is granted to a U.S. industry that has been hurt by a foreign country’s subsidizing its firms ---- U.S. Countervailing duty– Subsidies allow foreign firms to sell their products at lower

prices; countervailing duty seeks to counter the effect of the subsidy

– Problem: defining subsidy is subjective– The Uruguay Round defined subsidies as (1) a direct loan

or transfer, (2) preferential tax treatment, (3) the supply of goods or services other than general infrastructure, or (4) income and price supports

Antidumping Duties

• Antidumping duty: a tariff levied on an import that is selling at a price below the product’s fair value (usually described as below marginal cost) The Problem: Defining fair value is subjective; antidumping duties are thus a source of tension between countries

Dumping price below marginal cost

Supply

demand

THE DUMPING ISSUE

PRICE BELOW ANY WILLINGNESS TO SUPPLY

PREDATORY PRICING

BELOW WORLD PRICE

CONSUMERS BENEFIT BY a + b + c + d --- DOMESTIC IMPORT COMPETING PRODUCERS LOSE a

SO WHY LEGISLATE AGAINST DUMPING??

PRESERVE STOCK VALUE? RESIST PREDATORY PRICING? --- MAINLY THIS IS THE ISSUE

FORMS OF PRICE DISCRIMINATION ---- THE INTERNATIONAL SCENE ---- SOMETIMES MIXED WITH DUMPING STRATEGIES

Price

Quantity

Price

Quantity

International

Market 1

International

Market 2

Monopoly firm’s

Marginal cost

Demand

Demand

MR MR

Price

Quantity

Price

Quantity

International

Market 1

International

Market 2

Monopoly firm’s

Marginal cost

Demand

Demand

MR MR

MONOPOLY PRICEMONOPOLY PRICE

MONOPOLY QUANTITIES SOLD IN EACH MARKET

SELLING IMPORTS BELOW WORLD PRICE INSIDE A NATION

SUPPLY OR MC ABOVE AVC

DEMAND

PRICE

QUANTITY

SELLING PRICEWORLD PRICE

Back to Antidumping Duties

• WTO Rules: Dumping occurs when an exporter sells a product as a price below the one it charges in its home market USUALLY MEANING BELOW ITS HOME MARKET MARGINAL COST

– The Problem: Comparing domestic and foreign market prices is difficult because of the differences in the price of transportation, wholesale, and other add-ons

How do we determine that dumping has occurred?

• Three methods to determine whether a good is being dumped1. Comparing the price in third-country markets2. Estimating the cost of production --- to get

average and marginal cost3. Estimate the foreign firm’s production costs

(dumping occurs if the foreign firm is not selling at a price that provides a normal rate of return on invested capital)

• In order for antidumping duties to be allowed, the country claiming dumping must show that the dumping has caused material injury to its firms --- so we get all kinds of claims

• We had the steel industry squawk in the U.S.

• And currently we are having the tire industry noise --- there is now a tariff on Chinese tire imports being argued

– If dumping occurs without material injury, antidumping duty is not allowed

• Problems: Economic theory and legal definitions are not in agreement– If a firm is not earning above average profits somewhere, it

cannot maintain a price somewhere else that is below the cost

– Firms often sell below costs -- How do we pick it up? • May sell at below costs in order to penetrate a market• May go for extended periods selling at prices that do not cover

fixed costs as long as the costs of variable inputs (labor and materials) are covered

Investigation• U.S. firms can initiate antidumping actions by filing a petition

with the International Trade Administration (ITA) in the Department of Commerce

• If ITA finds dumping (or subsidization in the case of countervailing duty) occurred, the U.S. International Trade Commission (USITC) conducts an additional investigation to determine whether the dumping has posed substantial harm to the domestic industry

• The relative success of U.S. firms in proving foreign dumping has induced a growing number of firms to file petitions with ITA

• So now we go back to tariffs??

Escape Clause Relief

• Escape clause relief: this is a temporary tariff on imports to allow a domestic industry to escape the pressure of imports and thus obtain a period of adjustment - stall technique– Refers to a clause in the U.S. and GATT trade rules

– Initiated when a firm or industry petitions the USITC directly for relief from a surge of imports

– The petitioning firm or industry must show that it has been harmed by imports and not some other factor (e.g., poor management)

Section 301 Retaliation

• Section 301: section of the U.S. 1974 Trade Act that requires the U.S. Trade Representative (USTR) to take action against any nation that persistently engages in unfair trade practices– U.S. defines the meaning of unreasonable and

unfair trade practices– Action is launched by a request for negotiations

with the country in question

Monopolistic Competition prior to tradethis is the steady state monopolistic

competition

demandMR

AC

MC

Price

Quantity

MONOPOLISTIC COMPETITION

A FORM OF IMPERFECTLY COMPETITIVE MARKET STRUCTURE

PRICE > MC = MARGINAL COSTNO LONGER DO WE HAVE PRICE = MR=MARGINAL REVENUE = MCAS WE HAVE IN COMPETITIVE MARKETS

SO PRICE IS DERIVED FROM THE DEMAND CURVE AT THE POINT WHERE MR = MC AMD WE ALSO DERIVE THE QUANTITY

IN MONOPOLISTIC COMPETITION WE HAVE MONOPOLY CONDITIONS BUT ENTRY INTO THE MARKET IS EASIER THAN UNDER STRAIGHT MONOPOLY CONDITIONS --- FIRMS MOVE IN AND THEN THE SHARE OF INCUMBENT FALLS AND DEMAND FOR THE INCUMBENT DECLINES UNTIL WE REACH A STEADY STATE WHERE AVERAGE COST IS TANGENT TO THE DEMAND CURVE IN A LONG RUN STEADY STATE SETTING

demandMR

AC

MC

Price

Quantity

MONOPOLISTIC COMPETITION

A FORM OF IMPERFECTLY COMPETITIVE MARKET STRUCTURE

PRICE = AC > MC = MARGINAL COST IN THIS STEADY STATE CASE OF LONG RUN MONOPOLISTIC COMPETITION --- NO FIRM PULLS OUT OF THE MARKET AND NO NEW FIRMS ENTER THE MARKET

IN MONOPOLISTIC COMPETITION WE HAVE MONOPOLY CONDITIONS BUT ENTRY INTO THE MARKET IS EASIER THAN UNDER STRAIGHT MONOPOLY CONDITIONS --- FIRMS MOVE IN AND THEN THE SHARE OF INCUMBENT FALLS AND DEMAND FOR THE INCUMBENT DECLINES UNTIL WE REACH A STEADY STATE WHERE AVERAGE COST IS TANGENT TO THE DEMAND CURVE IN A LONG RUN STEADY STATE SETTING

--Trade opens up--Monopolistic Competition case and assuming the steady state condition (no exit, no new

entry)

These monopolistic forms doing business induce economies of scale and lower prices

Low prices around the world can be taken as “dumping activity”

This may or may not be the case ----- but prices can be on their way down ---- this is good, but markets can be made thin

If barriers can be set up to entry --- then this form of market migrates to the pure monopoly or the oligopolistic form

Now prices are administered by the monopolistic firm having international dominance

Then what happens to dumping activity?

Similar case for international monopsonistic firms shown in the next slide --- buy now there is a single buyer power

Or large nation case which forces price down on imports

Pugel’s illustration of the automobile market without and with trade under monopolistic competition

External Economies Magnify an Expansion in a Competitive Industry

(Pugel’s illustration again)