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Unformatted text preview: Trade Policy in a Super Size Me World * Phillip McCalman Department of Economics University of California-Santa Cruz firstname.lastname@example.org Abstract When a foreign monopolist sets a single market clearing price for its product, the sign of the optimal tariff is determined by the extent of pass through (also known as the terms of trade effect). However, when a foreign monopolist employs a second degree price discrimination mechanism in the domestic market the calculus of welfare maximization is very different. While there are still terms of trade effects from the imposition of a tariff, the existence of such effects are neither necessary nor sufficient to determine the sign of the optimal tariff. Instead the distribution of valuations within the population is the key determinant of the nature of policy intervention. This result differs significantly from the uniform price case and is driven by the incentive compatibility constraint which places the distribution of types at the center of the analysis. If there is a relatively large fraction of high valuation types in the population, then domestic information rents may be increased by subsidizing imports thereby increasing the consumption of the low valuation types and moving the incentive constraint in favor of the high valuation types. However, if the share of high types in the population is relatively small then the increase in information rents will also be small but the fiscal implications of a subsidy will be large. Consequently, the optimal policy will be to impose a trade tax. Key Words: Terms of Trade, Trade Policy, Discrimination JEL Classifications: F13, F15 * This paper was previously titled Trade Policy in the Presence of a Discriminating Foreign Monopolist. Id like to thank the University of Melbourne and the University of New South Wales for their hospitality in hosting me during the initial stages of this project. Id also like to thank a Bob Staiger and two anonymous referees for helpful comments and suggestions. Ricard Gil, Alan Spearot, Russell Hillberry and participants at several seminars and conferences also provided helpful suggestions. 1 Introduction Firms use a wide variety of techniques to sell their products. The diversity of methods extends far beyond the simple notion that a lower price will attract more consumers. Indeed the whole idea that firms rely on linear prices is challenged by the contracts offered for not only telecommunication services but also by the discounts for volume available in almost all retail outlets (e.g. 500ml of soft drink is more than half the price of 1000ml). Colloquially, the option to buy a bigger size at a lower average price, or a higher quality at a lower quality adjusted price, is an invitation to super size the purchase. The literature analyzing these techniques is vast but all studies have one feature in common, they all focus exclusively on a closed economy setting. The focus on closed economy models seems natural, especially since the working assumption regarding international trade is that...
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This note was uploaded on 03/16/2010 for the course ECON 100A taught by Professor Justinmarion during the Spring '08 term at UCSC.
- Spring '08