The Optimum Discriminatory Tariffs under the Cournot-Nash Strategy in International Trade

Abstract

This paper investigates the optimum ad valorem tariffs under the Cournot competition. There are three situations that exceptions to most-favored-nation (MFN) principle are made within the GATT framework: free trade agreement, ‘safeguard’ actions and escape clause. Hence, the issue of discriminatory tariffs has important policy implications. Most of the literature concerning the discriminatory tariffs assumes that the objective of the government is to maximize their country’s welfare by choosing the appropriate trade policy. We expand welfare-maximizing to loss-minimization model in order to comparing two types of optimum discriminatory tariff ratios. In the loss-minimization model, we assume that the objective of the government is to minimize loss in consumers’ surplus while subject to a minimum target level of tariff revenue. The aim of this paper is to show that the optimum ad valorem tariff ratio between two exporting countries can be unambiguously derived with a linear demand curve and constant marginal costs. We conclude that the welfare-maximizing tariff ratio differs from that of the loss-minimization model or a quasi-Ramsey rule. The Ramsey-like tariff ratio does not depend on the size of the intercept of market demand since its objective function is to minimize the loss in consumers’ surplus. On the contrary, the welfare-maximizing tariff ratio is dependent on the intercept since it is used to measure the total consumers’ surplus. Only when the two foreign producers have the identical marginal cost will they coincide.