Demand Behavior and Import Policy

Abstract

Some years ago, Brander and Spencer (1984) pointed out the possibility that a country might optimally pursue a policy of subsidizing its Imports if these are provided by a foreign monopolist. They pointed out that the case in which a subsidy instead of an ad valorem trade tax would be optimal requires that the elasticity of import demand decreases as price rises along the demand curve. Further comments in Jones (1987) linked this contribution to the standard observation that a monopolist facing a demand curve that has shifted inwards might nonetheless respond by raising price, the required condition being that the elasticity of the shifted demand curve be lower than the original curve at the initial price. Since a trade tax or subsidy involving a movement along a domestic demand curve is translated by a foreign monopolist as a shift in demand for prices received by the supplier, the direction of trade policy hinges upon the manner in which the elasticity of demand changes along a demand curve as price rises.