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Trade Policy: Home Market Effect vs Terms of Trade Externality

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  • Alessia Campolmi
  • Harald Fadinger
  • Chiara Forlati

    () (Chair of International Finance, Ecole Polytechnique Federale de Lausanne (EPFL), Switzerland)

Abstract

We study trade policy in a two-sector Krugman type model of trade. We conduct a general analysis allowing for three different instruments: tariffs, export taxes and production subsidies. For each instrument we consider unilateral trade policy without retaliation. When carefully disentangling the different effects that determine policy makers' choices and modeling general equilibrium effects of taxes/tariffs, we find that production subsidies are always inefficiently low and driven by terms of trade effects. In the cases of tariffs and export taxes the home market effect prevails for some parameter combinations but mostly trade policy is determined by terms of trade effects and the desire to reduce distortions arising from monopolistic competition. Hence, our analysis sheds new light on trade policy in a model of intra-industry trade.

Suggested Citation

  • Alessia Campolmi & Harald Fadinger & Chiara Forlati, 2009. "Trade Policy: Home Market Effect vs Terms of Trade Externality," Working Papers 200902, Center for Fiscal Policy, Swiss Federal Institute of Technology Lausanne, revised Sep 2009.
  • Handle: RePEc:cif:wpaper:200902
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    Keywords

    Home Market Effect; Terms of Trade; Tariffs and Subsidies;

    JEL classification:

    • F12 - International Economics - - Trade - - - Models of Trade with Imperfect Competition and Scale Economies; Fragmentation
    • F13 - International Economics - - Trade - - - Trade Policy; International Trade Organizations
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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