Ranking of Tariffs Under Monopoly Power in Trade

Abstract

In a recent paper in this Journal J. Bhagwati and M. C. Kemp considered the question of ranking tariffs in the presence of monopoly power in trade.' Under the assumption that the exportable goods in the tariff-imposing country were not inferior, the following proposition was established: the country could raise its welfare monotonically by raising tariffs up to a certain maximum (corresponding to the optimum tariff), and beyond this point a further tariff increase would monotonically reduce welfare to the point where protection was prohibitive. The demonstration was based on the implicit assumption that the foreign offer curve faced by the tariff-imposing country was well-behaved. This, however, need not be the case. Even if we assume (in the spirit of the Bhagwati-Kemp paper) that there are no internal commodity price distortions, factor price distortions, or imperfections in the redistribution of income, the foreign country may have a tariff. It then becomes possible, in the presence of inferior goods, for the foreign offer curve to yield multiple equilibria at given terms of trade. In this case it is easy to show that the Bhagwati-Kemp theorem no longer holds. Assume that the foreign country has a tariff and that its export good is strongly inferior. Then its offer curve will have all the properties described by Bhagwati and Kemp in their discussion of the tariff-imposing or country. This is illustrated in Figure I. With the home country's offer curve intersecting it from above in the backward-bending part of the curve, welfare will decline if a small tariff is imposed. As drawn, welfare continues to decline for tariffs up to a rate t, and then increases between the tariff rate t, and tariff rate t2 (while remaining below the free trade level). The welfare level then declines steadily for higher rates until at rate t, the tariff becomes just prohibitive. The corresponding tariff welfare curve is shown in Figure II. Note that, rather than impose