Endogenous timing, strategic tariff game and bilateral trade in vertical oligopoly

Abstract

AbstractThis paper builds an observable delay game in endogenous timing to study the possible occurrence of trade wars in a vertical, bilateral trade model. It examines the effects of production cost differences and order of moves on optimal tariffs, market equilibria, dumping margin and social welfare in both fixed timing and endogenous timing games. In a fixed timing game, it shows that price dumping in the intermediate good market arises from differences in country‐specific final good production costs. Different from Bernhofen (1995; Journal of International Economics), trade costs resulting from reciprocal tariffs in upstream markets can reverse the price dumping under certain conditions. In an endogenous timing game, this paper finds that the magnitude of cost differences significantly influences countries’ decisions on the order of moves in a strategic tariff‐making game. Both countries want to be the first movers under a small cost difference and consequently reach a simultaneous equilibrium result. This demonstrates that the second‐best equilibrium proceeds under certain conditions. Under a large cost difference, sequential policy‐making is the subgame perfect Nash equilibrium. If the cost difference is sufficiently large, both countries have an incentive to launch a trade war as a multiple equilibrium game.