Cannibalization, Import Tariffs, and Social Welfare in Vertical Product Differentiation

This paper investigates cannibalization trade in a vertical product differentiation where a high‐quality foreign and a low‐quality domestic firm compete in the domestic market. Our findings are as follows: (i) under specific conditions, the foreign high‐quality firm may adopt a cannibalization strategy and introduce either superb‐quality or medium‐quality products; (ii) introducing superb‐quality products does not affect the domestic firm's profit but enhance domestic consumer surplus and social welfare, and in such scenarios, theoretically, the guiding principle of domestic import‐tariff policy is to ensure the implementation of foreign cannibalization; (iii) introducing medium‐quality products with quality‐related costs adversely affects domestic social welfare. In this case, the government will set a sufficiently high tariff rate to deter such cannibalization.