Optimizing capacity investment and production planning in the presence of protective tariffs and market competition

Stringent tariff policies have forced multinational firms (MNFs) to evaluate the necessity of establishing new production capacities in their target markets to avoid high tariffs. We utilize a three-stage game-theoretic model to examine the capacity investment and production decisions of the MNF facing raw materials and finished goods tariffs, as well as competition from the local firm. Our findings indicate that intensified competition does not necessarily erode profitability; under certain demand scenarios, cost‑advantaged firms may achieve enhanced profits. Moreover, rather than universally deterring capacity investments, competition may stimulate higher capacity levels compared to a monopolistic setting. Furthermore, higher raw material tariffs diminish the investment motivation of the MNF and decrease its optimal capacity, while finished goods tariffs enhance investment willingness only under moderate capacity investment cost conditions. Finally, tariffs tend to depress MNF production and profitability while enhancing the output and profits of the local firm, albeit at the expense of consumer welfare. However, in certain circumstances, an increase in finished goods tariffs can inadvertently boost the expected output of the MNF while harming the profitability of the local firm.