Abstract

AbstractFirms which face the threat of import competition from foreign rivals are conventionally seen as favouring import protection. We show that this is not necessarily the case when domestic firms’ input prices are determined endogenously. In a framework where the input price is determined through contracting with an upstream agent, which could be an input supplier or a labour union, the relationship between a domestic downstream firm's profits and the number of foreign competitors depends on trade costs and the curvature of the demand function. If trade costs are sufficiently high, an increase in the number of foreign entrants can raise the profits of a downstream firm in a home market characterised by Cournot competition. For any concave and linear demand function and for any demand function which is not ‘too convex’, this occurs due to the upstream agent moderating its input price allowing downstream firms to increase profits. For sufficiently convex demand functions, on the other hand, profit‐raising entry still occurs, albeit through a substantively different mechanism, and depending upon the extent to which an increase in the input price is passed on to the final consumer.

Highlights

  • In the standard Cournot model of oligopoly, each firm’s profits decrease as the number of firms competing in the product market increases (Seade, 1980a)

  • We consider the potential impacts on profits of domestic downstream firms in vertical markets when confronted by foreign entry into the home market

  • In our general model which accommodates any demand curvature, we have established that the profits of incumbent domestic downstream firms can be increasing with the entry of foreign rivals, a result which arises if trade costs are sufficiently high

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Summary

Introduction

In the standard Cournot model of oligopoly, each firm’s profits decrease as the number of firms competing in the product market increases (Seade, 1980a). We show that when a firm’s costs are determined endogenously through contracting with an upstream agent (either an input supplier or a labour union) in the domestic market, the relationship between profits-per-firm and the number of foreign entrants depends on trade costs and demand curvature. We derive conditions under which the payoff of the upstream agent decreases with entry of foreign downstream rivals This occurs for every concave or linear demand function or any demand function which is not ‘too convex’, or alternatively, when the competition in the downstream market is characterised by strategic substitutability.

Literature review
The model
The effects of entry on profits
Examples
The effects of entry on the profits of the upstream agent
The impact of home bias
The impact of the number of firms in the domestic industry
The effects of trade liberalisation
Conclusions
Full Text
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