Oligopoly and Trade

Notes 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

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Oligopoly and Trade

Plan of Lectures

Motivation
Duopoly in Partial Equilibrium
Trade Costs: "Reciprocal Dumping"
Oligopoly in General Equilibrium
Extensions

J.P. Neary (University of Oxford)

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November 26, 2009

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Motivation
So far: "Imperfect competition" = Monopolistic Competition
BUT: Only one form; closest to perfect competition
Shares many properties:
1
2

Atomistic rms, ex ante identical;

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
2

Size distribution of rms under perfect or monopolistic competition

Oligopoly: Small-group interaction.

Seems worth exploring oligopoly in trade too; for short run at least.
J.P. Neary (University of Oxford)

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November 26, 2009

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Duopoly in Partial Equilibrium

Brander (JIE 1981):
Two countries, fully symmetric, one rm in each, partial equilibrium:
Firms
Home Foreign
Markets
Home
x
y
Foreign
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).
J.P. Neary (University of Oxford)

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Duopoly in Partial Equilibrium

Autarky versus Free Trade: Figure
y
F

H
B

F'

H'

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.
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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 moves
away from both autarky and free trade.

J.P. Neary (University of Oxford)

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November 26, 2009

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Trade Costs: "Reciprocal Dumping"

Components of Home Welfare: Figure

*
t

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

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Trade Costs: "Reciprocal Dumping"

The Linear Example

Linear demands; constant marginal costs.

p = a bX X = x + y p = a bY
= (p c )x + (p
c t )x

Y = x +y

Home Firms FOCs:

H : p c bx = 0 ! a c 2bx by = 0
H : p
c t bx = 0 ! a c t 2bx
by = 0
2 1
bx
a c
Equilibrium in home market:
=
1 2
by
a c
t
+c +t
! x = a 2c3b
y = a 2c 3b 2t +c
Symmetrically: x = a 2c 3b2t +c
y = a 2c3b+c +t
1
A
Autarky: y = 0 ! t = 2 (a 2c + c ) ! x A = a2bc

Prots on Home Sales:

2
2 dx
2
d2
= bx 2 ! ddt = 2bx dx
dt = 3 x > 0 ! dt 2 = 3 dt = 9b > 0
i.e., " in t raises home sales linearly, and raises prots on home sales by
more the higher they are already (i.e., the higher is t):
So, prots on home sales are convex in t.

J.P. Neary (University of Oxford)

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Trade Costs: "Reciprocal Dumping"

The Linear Example II

Prots on Exports:
= b (x )2 x =
d
dt

dx
dt

a 2c 2t +c
3b
= 43 x <

8
!
= 2bx
0 ! ddt2 = 43 dx
dt = 9b > 0
i.e., " in t lowers export sales linearly, but lowers prots on these sales
by 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 ( + )

= 23 x 43 x
8 dt
< < 0 when x = x (i.e., t = 0)
> 0 when x = 0 (i.e., t = t A )
:
= 0 when x = 2x (i.e., t = t M =
J.P. Neary (University of Oxford)

Oligopoly and Trade

a 2c +c
5

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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 sales
are 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 are
harmed by an equal fall in rivals costs;
Hence total sales rise for a small reduction in t at autarky, and
continue 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 on
prots in the export market,
whereas home sales are initially maximal, so the fall in sales has a
rst-order eect on home-market prots;
Hence, overall prots fall for a small reduction in t at autarky.
J.P. Neary (University of Oxford)

Oligopoly and Trade

November 26, 2009

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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 equilibrium
So: We need to do this: Put Oligopoly into G eneral E quilibrium:
"GOLE "

J.P. Neary (University of Oxford)

Oligopoly and Trade

November 26, 2009

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