Reciprocal dumping
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All the theories we have seen so far are in fact general
equilibrium models.
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Useful to understand the effect of trade openness on the
production, employment, wages and welfare structures.
But they omit firms’ strategic behaviors.
…and many industries are in fact oligopolies where firms
acknowledge their impact the market.
Reciprocal dumping
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In the late 1970s, a new theory of international trade was born, inspired
by industrial economics.
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James Brander, Barbara Spencer, Paul Krugman.
Provide a framework to analyse international competition within an
oligopoly.
It is a more « micro-economic » analysis, in partial equilibrium (only
focused on a given industry)  wages and demand are exogeneous.
Here, we consider a duopoly.
Reciprocal dumping
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Two countries.
One firm in each country.
They produce exactly similar goods (different from Krugman)= one price
on each market.
After openness, each firm is going to sell to the foreign market, after
paying a transport cost
Reciprocal dumping
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Each exporting firm has to pay a transport cost  for each unit
Firms compete in terms of quantity (Cournot competition)
Cost function:
Inverse demand function:
Each firm maximizes its profit on each market.
On the foreign market:
Reciprocal dumping
Firm 1 chooses Q1 (how much to export):
P
aQ1  bQ12  bQ1Q2  cQ1  Q1
Ibid firm 2
Firms’ reaction functions = best possible reaction to the competitor
Reciprocal dumping
Reciprocal dumping
Equilibrium is defined by the intersection of reaction functions
(both firms max. profits given the strategy of the other firm:
Nash equilibrium):
The higher the transport cost, the larger the market share of
the domestic firm. If τ > (a – c)/2
then
Q1 = 0. The
equilibrium price on the foreign market is therefore:
The higher the transport cost, the higher the price
Reciprocal dumping
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Conclusion 1: Type of trade
1.
2.
3.
Even if the domestic firm has to pay an extra cost, it can sell
on the foreign market.
The foreign firm is also going to sell on the domestic market
 We get «perfect» intra-industry trade.
In order to sell at a competitive price on foreign markets,
firms have to reduce their margins  Firms have different unit
margins for different markets.
= reciprocal dumping.
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The price increases
transport cost.
less
than
proportionately
with
the
Trade versus autarky with reciprocal dumping
In autarky, firm 2 has a monopoly over its market. The output is:
After openess, the overall quantity offered is:
QT>Qta if Q1>0
(<(a-c)/2)
The autarky price is:
In autarky, lower quantities & higher price than if Q1>0
Reciprocal dumping
Conclusion 2: Gain to trade?
1.
2.
3.
4.
5.
Trade fosters competition: quantities increase,
prices go down, consumers are the winners 
pro-competitive effect.
Profits go down  Firms lose.
Trade implies transport costs for identical
goods: efficiency loss
Openness can lead to the exclusion of one of
the two firms if it is less productive  there is
a new monopoly on the foreign market…
…but the monopolist is more efficient  Gain
of rationalization