The Gain from Exploiting Monopoly or Monopsony Power in International Trade

Abstract

The argument for protection, and the prospective gains for a country to be had by exploiting it, play a large part in the literature of trade policy for economic development. There is a widespread impression in this literature that the potential gains available to under-developed countries from this source are substantial. This Note investigates the problem, using some very simple models of the welfare derivable from trade, selected because they are capable of yielding quantitative results. Its purpose is to call attention to the generally neglected points that while the optimum tariff rate varies inversely with the elasticity of demand for exports or supply of imports, and may be surprisingly high when the relevant elasticity is low, the gain in real income derivable from applying the optimum tariff depends on certain structural characteristics of the tariff-imposing country, which may be such as make the resulting gain relatively small by comparison with the level of welfare enjoyed under free trade. In the first place, the gain depends on the nature of the domestic preference system, and especially on the elasticities of substitution between imports and exports in domestic consumption-and production-and will tend to be low when those elasticities are low, as they are generally presumed to be for lessdeveloped countries. In the second place, the gain depends on the magnitude of the free-trade ratio of imports to national income, and will tend to be lower the lower that ratio; and while this ratio may be assumed to be generally higher for less developed than for developed countries, its influence on the order of magnitude of the gain from optimum tariff policy is a relevant consideration. Throughout it is assumed that the economy contemplating imposing an optimum tariff is completely specialized in producing a fixed amount of Xof its exportable good, which it exports in return for its import good Y. This assumption is not as restrictive as it may seem, since X may be taken as a measure of the economy's total productive capacity, and the possibility of substituting for imports through domestic production absorbed into the magnitude of the elasticity of substitution in consumption. It is also assumed that the preference system of the country is homothetic-goods would be consumed in the same ratios at the same relative prices regardless of income level, i.e. the income elasticity of demand for each is unity-and that the marginal utility of income is constant. A little mental experimentation with the usual optimumtariff geometry will show that the former assumption will overstate the gains from an optimum tariff policy if, as it seems reasonable to