Tariffs and the Extraction of Foreign Monopoly Rents Under Potential Entry

Abstract

This paper examines the incentives for using tariffs to extract monopoly rents from imperfectly competitive foreign firms. Under imperfect competition price exceeds marginal cost so that a country which imports such a good pays a rent to the foreign firm (unless the firm happens to earn only normal profits). Tariffs can be used to extract some of this rent. On the basis of a simple Stackelberg entry deterrence model, the paper shows that the rent-extracting policy is particularly attractive if the foreign firm faces a threat of domestic entry. In the special case in which a domestic entrant would produce only for its home market some rent can be extracted without reducing the level of imports or domestic consumption of the good. Despite transportation costs, it is shown that the Stackelberg leader-follower model can lead to intra-industry trade in the same commodity. The rent-extracting tariff policy is then examined in the case that a potential domestic entrant may produce both for the home and export markets.

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