Abstract
This article focuses on the optimal international trade policy considered product differentiations. A duopoly model with a home firm in a developing country and a foreign firm in a developed country is established. The findings indicate that, the optimal tariff relies on the product differentiations significantly. On one hand, higher marginal cost of home firms have opposite effects on optimal tariff compared to higher marginal cost of foreign firms. On the other hand, the optimal tariff is monotonically decreasing in the amount of consumers caring about brands and increasing in the scale of consumers not caring about brands. Moreover, an increase in the marginal cost and transportation cost of imported goods triggers price rising in domestic market as the market power of home firms is consolidated. In addition, a foreign firm may withdraw from domestic market if its competitive advantages vanishes under high tariffs.
Highlights
International trade plays an extremely important role in the modern global economy
According to Proposition 1, higher marginal cost of home firms have opposite effects on optimal tariff compared to higher marginal cost of foreign firms
The effects of product differentiations, which include horizontal differentiations referring to the differences in marginal costs and vertical differentiations referring to the differences in brands, on the optimal trade policies are investigated theoretically
Summary
International trade plays an extremely important role in the modern global economy. Both developed and developing countries participate in international trade to stimulate economic growth. Tariff is the most commonly used policy for trade protection, which creates higher entrance barrier for foreign firms. Such evidence could be found in the recent trade war initiated by Trump government of the U.S with an increase of the tariff on imported goods from other countries like Canada, China, and Mexico. The major findings indicate that, product differentiations have significant impacts on the optimal trade policies, while the distribution of consumer preference matters.
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