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Strategic Trade Policy and Vertical Product Differentiation: intra-industry trade between developed and developing countries

  • Michael Kunin
  • Kresimir Zigic

We analyse the effects of simple strategic trade policy in a duopoly with vertical product differentiation where firms from a developed and less developed country compete in both qualities and prices in the domestic market. The distinction between the developed and developing country firm is captured through the difference in the marginal efficiency in production of quality, where the latter has lower marginal efficiency than the former. We concentrate on the case when the domestic market is in a less developed country and when it possesses the characteristics of a "natural duopoly". That is, the size of the market is such that only two firms can survive in it. We analyse under which conditions welfare maximising trade policy in the form of tariffs can lead to so-called quality reversal, that is, to the situation in which an initially low quality domestic firm will jump up the quality ladder in anticipation of the optimal trade policy. We then contrast our findings with related results concerning quality reversal in the relevant trade literature.

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Paper provided by The Center for Economic Research and Graduate Education - Economics Institute, Prague in its series CERGE-EI Working Papers with number wp230.

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Date of creation: Sep 2004
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Handle: RePEc:cer:papers:wp230
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  1. Zhou, Dongsheng & Spencer, Barbara J. & Vertinsky, Ilan, 2002. "Strategic trade policy with endogenous choice of quality and asymmetric costs," Journal of International Economics, Elsevier, vol. 56(1), pages 205-232, January.
  2. Moraga-Gonzalez, Jose Luis & Viaene, Jean-Marie, 2005. "Trade policy and quality leadership in transition economies," European Economic Review, Elsevier, vol. 49(2), pages 359-385, February.
  3. Gruenspecht, Howard K., 1988. "Export subsidies for differentiated products," Journal of International Economics, Elsevier, vol. 24(3-4), pages 331-344, May.
  4. Peter K. Schott, 2004. "Across-product Versus Within-product Specialization in International Trade," The Quarterly Journal of Economics, MIT Press, vol. 119(2), pages 646-677, May.
  5. Carmichael, Calum M., 1987. "The control of export credit subsidies and its welfare consequences," Journal of International Economics, Elsevier, vol. 23(1-2), pages 1-19, August.
  6. David Greenaway & Robert Hine & Chris Milner, 1994. "Country-specific factors and the pattern of horizontal and vertical intra-industry trade in the UK," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 130(1), pages 77-100, March.
  7. Avner Shaked & John Sutton, 1982. "Natural Oligopolies and the Gains from Trade," STICERD - Theoretical Economics Paper Series 51, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  8. Herguera, Inigo & Kujal, Praveen & Petrakis, Emmanuel, 2002. "Tariffs, quality reversals and exit in vertically differentiated industries," Journal of International Economics, Elsevier, vol. 58(2), pages 467-492, December.
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