MULTI-NATIONAL MONOPOLIES AND MONOPOLY REGULATION *

Abstract

THE welfare analyses of monopoly pricing and government policies towards monopolies have traditionally been concerned with closed economy situations where the firm produces and sells in one country only. However with the growing importance of large firms in international trade and investment it seems desirable to extend such analyses to open economy situations. This paper examines the optimal policy for the home country when a firm has substantial market power in the home and foreign countries and trades between them. In closed economy situations the optimal policy is as follows: either give a production subsidy or a consumption subsidy to induce the firm to set price equal to social marginal costs, or order it to set that price. In comparison, the open economy case may be more complicated. There are two reasons for expecting this. First, if the firm's sales in home and foreign markets are simultaneously determined the government's policy would need to influence foreign as well as home operations; however the government may be constrained in this if it can not exercise extra-territorial jurisdiction. Secondly, although an appropriate production subsidy will induce the firm to set social marginal costs in home production equal to price, it is not obvious that that will also generate the socially optimal level of intra-firm trade. Some further policies may be required. The analysis here builds upon Horst's (1973) model of a multi-national firm. Following him I assume that the firm dominates the industry concerned and can practice price discrimination between home and foreign markets. Also for simplicity I assume that there are no profits taxes. For the most part I assume that the firm produces in the home country only. In Sections II and III the analysis keeps to the increasing costs case. Section II examines a divergence between the firm's (private) costs and benefits of exports and the social costs and benefits. Section III considers the country's optimal policies in the face of that divergence. Section IV considers the decreasing costs case. Section V briefly discusses the implications of the firm setting up production in the foreign country. Section VI sums up the main findings of the paper. Throughout the main text of the paper we rely on a diagrammatic exposition. An Appendix gives formal proofs of the propositions discussed in the text.