Abstract
In his seminal work on retaliation, Johnson (Review of Economic Studies, 21, 1953-1954) showed that a country will win a bilateral tariff war if its relative monopoly/monopsony power in world trade is sufficiently large. However, it is unclear from Johnson's analysis and from subsequent research on the subject how this power is determined in general economic environments. An important goal of this paper is to address this issue. With the help of a neoclassical trade model in which country size is at centre stage, it is shown that a sufficient condition for a country to prefer a non-cooperative Nash equilibrium (retaliation) over free trade is that its relative size be sufficiently large. The paper also refines the structure of the general trade model and generates additional characterization results on the importance of country size for best-response functions, retaliatory tariffs, and welfare.
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