Quotas and tariffs with endogenous conduct

Abstract

This chapter utilizes the results of Deneckere ·& Kovenock (1988, 1989, 1992, 1996) on price setting games with capacity constraints and different unit costs up to capacity to analyze the effects of quotas and tariffs in a model in which a domestic market for a homogeneous product is supplied by a duopoly consisting of a domestic and a foreign firm. A model of the timing of price setting is constructed in which the existence of price leadership, as well as the identity of the leader, depends upon the vector of unit costs and capacities (k1, k2, c1, c2). With firm 1 the foreign firm and firm 2 the domestic firm, the levying of a tariff raises the foreign unit cost of production up to capacity to c1t = c1 + t, while the imposition of a ‘binding’ quota reduces capacity from k1 to k1q (the level of the quota). The effects of quotas and tariffs on the equilibrium in the game of timing are examined starting from an initial vector in which costs are identical, c1 = c2 = c. It is shown that, due to the endogeneity of price leadership, trade restrictions can have surprising effects. In addition to the traditional view that quotas hurt the foreign firm and help the domestic firm, and the results of Harris (1985) and Krishna (1989) that quotas may help both firms, we show that with endogenous timing a quota can make the domestic firm worse of and the foreign firm better off (by altering the identity of the price leader). However, a quota will always (weakly) increase price. In contrast, a tariff always (weakly) hurts the foreign firm and (weakly) helps the domestic firm but may, by affecting the leadership role, lower price. The question of the equivalence of quotas and tariffs is also examined. In contrast to the result of Deneckere & Kovenock (1989) for the simultaneous price setting game, we show that with the endogenous timing of price-setting there are certain initial conditions (k1, k2, c1, c2) for which the prices and quantities generated by a ‘binding’ quota can be duplicated by a tariff (and vice versa). It is possible, however, that a quota that reduces the foreign capacity slightly is equivalent only to a very severe tariff. We conclude by showing how the model allows for simple welfare comparisons in environments in which protection is likely.

Citation

Deneckere, R.J., Kovenock, D. and Yeop Sohn, Y. (2000), "Quotas and tariffs with endogenous conduct", Baye, M.R. (Ed.) Industrial Organization (Advances in Applied Microeconomics, Vol. 9), Emerald Group Publishing Limited, Leeds, pp. 37-68. https://doi.org/10.1016/S0278-0984(00)09045-3