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 countrys 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 products 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 firms Marginal cost Demand MR

Price Quantity Price Quantity International Market 1 International Market 2 Monopoly firms Marginal cost Demand MR MONOPOLY PRICE MONOPOLY QUANTITIES SOLD IN EACH MARKET

SELLING IMPORTS BELOW WORLD PRICE INSIDE A NATION SUPPLY OR MC ABOVE AVC DEMAND PRICE QUANTITY SELLING PRICE WORLD 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 dumped 1.Comparing the price in third-country markets 2.Estimating the cost of production --- to get average and marginal cost 3.Estimate the foreign firms 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 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 trade this is the steady state monopolistic competition

demand MR AC MC Price Quantity MONOPOLISTIC COMPETITION A FORM OF IMPERFECTLY COMPETITIVE MARKET STRUCTURE PRICE > MC = MARGINAL COST NO LONGER DO WE HAVE PRICE = MR=MARGINAL REVENUE = MC AS 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

demand MR 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

Pugels illustration of the automobile market without and with trade under monopolistic competition

External Economies Magnify an Expansion in a Competitive Industry (Pugels illustration again)