This paper analyzes the welfare effects of a host-country tariff in the presence of endogenous transfer prices. The high transfer price and the low transfer price scenarios are analyzed in the presence of "arm's length” restraints on a foreign multinational. The welfare analysis decomposes the various elements which influence the tariff rate. Under the high transfer price regime the host country's welfare maximizing tariff is negatively related to the foreign price elasticity of demand for the multinational's product, and under the low transfer price regime it is related positively to the slope of the multinational's cost curves in the foreign country. Further, under arm's length restraints, it is never optimal for the host country to charge the: "critical” tariff rate at which the multinational is indifferent between a low or a high transfer price. [F13, F23]
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