Reciprocal Dumping Model of International Trade

Brader, James and Krugman, Paul (1983)

S. BharathiRahul Singh

Ashish BharadwajArindam Jana

IntroductionWhat is “dumping”?

• If a profit maximizing firm believes it faces a higher elasticity of demand abroad that an home, and it is able to discriminate between foreign and domestic markets, then it will charge a lower price abroad than at home. This is dumping.

• Such an explanation seems to rely on “accidental” differences in country demands.

Dumping contd…• Under the assumptions of imperfectly

competitive segmented markets. (Helpman, 1982)

• Seen to be welfare improving. • However it is still a controversial issue in trade

policy, where it is widely regarded as an “unfair” practice subject to rules and penalties.

QDOM QMON

MRDOM

DDOM

DFOR = MRFOR

P, C

QO

MC

PFOR

PDOM

ExportsDomestic Output

Total Outputs

“Reciprocal” Dumping

• Brander (1981) argues that oligopolistic rivalry between firms would naturally give rise to RD – Each firm dumps into other firms’ home market.

• The model tries to show that free entry gives rise to welfare improvement, ex post; but it is possible that welfare may decline.

The Model

• Basic Cournot Duopoly Market.• Positive transportation costs incurred in

exporting goods• Identical countries• Producing single identical (Brader,1981)

commodity, Z, with symmetric cost structures

• Constant marginal costs, c

The profit functions of each firm is as below:* * * *. ( ) . ( ) ( )x p Z x p Z c x x g Fπ = + − + −

* * * ** . ( ) . ( ) ( ) *y p Z y p Z c y y g Fπ = + − + −

By symmetry we need to only consider the domestic country

Best Reply Function (First Order Conditions)

. '( ) 0x x p Z p cπ = + − =* . '( ) 0y y p Z p c gπ = + − = 0 1g≤ ≤

Their solution is the trade equilibrium

• Let σ = y/Z = y/x+y, the foreign share in domestic market, and,

• ε = -p/Z.p’, elasticity of domestic demand

Rewriting the implicit best-reply functions, we get,

and,( )1p cε ε σ= + −

( )p c gε ε σ= −

Solving for σ and p we get,

( ) ( )1 2 1p c g gε ε= + −

Assuming that the second order conditions are satisfying the maxima (proof in Seade (1980) and Friedman (1977); shown as in the case of non-cooperative models),

•Own marginal revenue declines when other firm increases output

•Equivalent to downward sloping best response functions

•They imply stability, and if held globally, an unique equilibrium

( )( ) ( )1 1 1g gσ ε= − + +

Best response functions

(using constant elasticity demand, p=A.Z-1/ε)

• Reciprocal dumping occurs when monopoly mark-ups exceed transport costs ex-ante

• RD is not Pareto Efficient since monopoly distortions exists ex post

• The question, however, is whether in the second best world free trade is superior to autarky or not?

• Trade Welfare loss/gain ?

Conflicting effects on welfare

Prohibitive level: p=c+t and y=0Since dZ/dt = dx/dt + dy/dt

dW/dt > 0 since dx/dt > 0A slight fall in transport cost tends to make domestic output (x) fall as imports (y) come in. Therefore, a slight fall in t from the prohibitive level would reduce welfare.Decline in costsRise in consumptionLoss due to replacement of domestic production

•After trade, price movements explain changes in welfare

•Price falls welfare rises

•This can be shown by the fall in price ex post

Welfare Effects Under Free EntryRewriting the implicit best-reply functions under the n firms case and solving for σ and p, we get

( ) ( )1 2 1p c n g g nε ε= + −

( )( ) ( )1 1 1n g gσ ε= − + +

FOC for each firm maximizing profit is:

Also, each firm earns zero profit because of free entry

Proof:

(from FOC)

=>

>0 (from second order assumptions)

Therefore profits can now be given as:

•If Δp, Δx ≥ 0 => (p-c)xi – F > 0

•(p*-c/g) x*I > 0 since p*>c/g if trade takes place

Therefore, profits must be strictly positive which is a contradiction

Price falls => Welfare rises

Conclusion• Oligopolistic interaction between firms can cause

trade in the absence of any usual motivation for trade

• Neither cost differences nor economies of scale are necessary

• Interesting welfare effects of RDLow TC positive profits welfare increaseHigh TC loss welfare decline

Free entry Cournot model increases welfare

• If we move from Cournot model to Bertrand model, RD does not arise in the homogenous product case product differentiation required

• Important element is just that firms have a segmented markets perception

• Given this perception, this kind of trade is relatively robust

• This model of RD can be extended to a two-way FDI model (Baldwin & Ottaviano, 2001)

Friberg (2005) has investigated whether transport cost losses from trade can outweigh the partial equilibrium gains from trade (stronger competition and more brands to choose from).

He has evaluate the empirical relevance of the proposition that trade can lower welfare through wasteful transportation.

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