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Published: 21-12-2012, 17:49

Oligopoly: The Partial Equilibrium Approach


Oligopoly: General Equilibrium and Oligopoly

Oligopoly: The Gains from Trade

In the first stage of development, the partial equilibrium approach dominated the literature with representative contributions by Dixit (1984), Brander and Spencer (1985), Eaton and Grossman (1986), and Brander and Krugman (1983). Global firms can sell in an integrated worldmarket, segmentedmarkets in each country (Dixit 1984; Brander and Krugman 1983), or in some outside country (Brander and Spencer 1985; Eaton and Grossman 1986). The market is integrated if arbitrage keeps prices at home tied to foreign prices. Themarket is segmented if there is no arbitrage to keep prices in different markets in line. With tariffs and quotas, imperfect markets are best considered segmented.

Probably the most interesting and yet most controversial contribution is the one by Brander and Spencer (1985), which shows that subsidizing the exports froma domestic firmcan be beneficial to the economy by a strategic trade policy that transfers oligopoly profits from a foreign firm to the home firm in the same industry. This result was made intuitively clear by Eaton and Grossman (1986), who showed that by a different assumption regarding the behavior of firms it was optimal to tax rather than subsidize the export of the oligopoly. Why the difference? The explanation is extremely simple: if we assume the oligopolist is too conservative toward rivals, the government should subsidize its exports; if the oligopolist is too aggressive, the government should tax its exports. If the economist cannot distinguish between these two cases in practice, then our information does not allow a recommendation. The difference arises in the model as the difference between Cournot and Bertrand competition. Cournot is competition in quantities; Bertrand is competition in prices. Assume a firm in country A and one in country B compete in a thirdmarket with goods that are imperfect substitutes. In the case of Cournot competition, the firm assumes that the other firmwill maintain its output; in truth, if it expands output, the other will contract its output. Had the firm known this, it would have expanded its output even more. In the case ofBertrand competition, the firmassumes the other firm will maintain its price; in truth, if it lowers the price, the other firm will lower its price. Had the firm known that, it would have lowered its price by a smaller amount. Thus the existence of oligopoly profits does not seem to have raised the likelihood of a beneficial trade policy over and above traditional optimum tariff arguments. Even if strategic trade policies can be identified, they run into the same familiar problems: (1) governments correctly calculating optimizing tariffs or subsidies, (2) foreign retaliation can eliminate the benefits, (3) costly economic rent seeking by industries alerted to the policies, and (4) raising the cost of classifying goods for customs enforcement.

Brander (1981) and Brander and Krugman (1983) examine the role of price discrimination in international trade. In this case, it is assumed that there is an international oligopoly in which each country is a segmented market. Oligopolistic firms can raise profits by cutting prices in themarket with a higher elasticity of demand. This implies that the standard theory of price discrimination can be applied, because now firms, regardless of their location, will sell in all markets at the prices prevailing in each segmented market. There now may be crosshauling, or wasted transportation costs as even identical goods move in both directions (Brander and Krugman 1983). A felicitous mental picture would be two logging trucks going in opposite directions and carrying identical logs.

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