International Trade Theory and Policy
by Steven M. Suranovic
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Trade 100-6
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Monopoly/Monopsony Power in TradePerhaps surprisingly, "large" importing countries and "large" exporting
countries have a market imperfection present. This imperfection is more
easily understood if we use the synonymous terms for "largeness," monopsony
and monopoly power. Large importing countries are said to have "monopsony
power in trade", while large exporting countries are said to have "monopoly
power in trade" As this terminology suggests, the problem here is that
the international market is not perfectly competitive. For complete perfect
competition to prevail internationally, we would have to assume that all
countries are "small" countries. Let's first consider monopoly power. When a large exporting country implements
a trade policy it will affect the world market price for the good.
That is the fundamental implication of largeness. For example, if
a country imposes an export tax, the world market price will rise
because the exporter will supply less. It was shown in Section
90-23 that an export tax set optimally will cause an increase
in national welfare due to the presence of a positive terms of trade
effect. This effect is analogous to that of a monopolist operating
in it's own market. A monopolist can raise its profit (i.e., its
firm's welfare) by restricting supply to the market and raising
the price it charges its consumers. In much the same way, a large
exporting country can restrict its supply to international markets
with an export tax, force the international price up, and create
benefits for itself with the terms of trade gain. The term monopoly
"power" is used because the country is not a pure monopoly in international
markets. There may be other countries exporting the product as well.
Nonetheless, because its exports are a sufficiently large share
of the world market, the country can use its trade policy in a way
that mimics the effects caused by a pure monopoly, albeit to a lesser
degree. Hence the country is not a monopolist in the world market
but has monopoly "power" instead. Similarly, when a country is a large importer of a good we say that it
has "monopsony power." A monopsonist represents a case in which
there is a single buyer in a market consisting of many sellers.
A monopsonist raises his own welfare or utility by restricting his
demand for the product and thereby forcing the sellers to lower
their price to him. By buying fewer units at a lower price the monopsonist
becomes better-off. In much the same way, when a large importing
country places a tariff on imports, the country's demand for that
product on world markets falls, which in turn lowers the world market
price. It was shown in Section 90-8
that an import tariff, set optimally, will raise national welfare
due to the positive terms of trade effect. The effects in these
two situations are analogous. We say that the country has monopsony
"power" because the country may not be the only importer of the
product in international markets, yet because of its large size
it has "power" like a pure monopsonist. Trade Policy: 1st-Best or 2nd-Best It has already been shown that trade policy can improve a country's national
welfare when that country is either a large importer or a large exporter.
The next question to ask is whether the optimal tariff, or the optimal
export tax, each of which is the very best "trade" policy that can be
chosen, will raise national welfare to the greatest extent. Or, whether
there is another, purely domestic, policy that can raise welfare to a
larger degree. Because a formal graphical comparison between the first-best and second-best
policies is difficult to construct in this case, we will rely on
an intuitive answer based on what has been learned so far. It is
argued in Section 100-2 that the first
best policy will always be that policy that attacks the market imperfection
or market distortion most directly. In the large country case it
is said that the market imperfection is a country's monopsony or
monopoly power. This power is exercised in "international" markets,
however. Since benefits accrue to a country by changing the international
terms of trade in a favorable direction, it is through trade that
the monopsony or monopoly power can "best" be exercised. This observation
clearly indicates that trade policies will be the first-best policy
options. When a country is a large importing country, an optimal
tariff or import quota will be first-best. When a country is a large
exporting country, an optimal export tax or VER will be first-best.
Now of course, this does not mean that a purely domestic policy cannot
raise national welfare when a country is "large." In fact, it was
shown (Section 95-3) that an import
tariff is equivalent to a domestic production subsidy and a domestic
consumption tax set at the same level, thus, setting one of these
policies at an appropriate level may also be able to raise national
welfare. To see that this is true, let's consider a large importing
country initially in free trade. Because it is in free trade, there
is a market imperfection present that has not been taken advantage
of. Suppose this country's government implements a production subsidy
provided to the domestic import competing firm. We can work out
the effects of this production subsidy in the adjoining figure.
The free trade price is given by PFT. The domestic supply in free trade is S1 and domestic demand is D1 which determines imports in free trade as D1 - S1(the red line).
When a specific production subsidy is imposed the producer's price rises,
at first by the value of the subsidy. The consumer's price is initially
unaffected. This increase in the producer's price induces the producer
to increase its supply to the market. The supply rises along the supply
curve and imports begin to fall. However, because the country is a large
importer, the decrease in imports represents a decrease in the world demand
for the product. As a result, the world price of the good falls, which
in turn means that the price paid by consumers in the import market also
falls. When a new equilibrium is reached, the producer's price will have
risen (to PP in the diagram), the consumer's price will have
fallen (to PW), and the difference between the producer and
consumer prices will be equal to the value of the specific subsidy (s
= PP - PW). Note that the production subsidy causes
an increase in supply from S1 to S2, and an increase
in demand from D1 to D2. Because both supply and
demand rises, the effect of the subsidy on imports is, in general, ambiguous.
The welfare effects of the production subsidy are shown in the Table
below. The letters refer to the area in the previous graph. Red
letters indicate losses while black letters indicate gains.
The first thing to take note of, is that the production subsidy causes
welfare improvements for both producers and consumers. All previous policies
have these two groups always experiencing opposite effects. It would appear,
in this case, we have struck the "mother lode"; finally a policy that
benefits both consumers and producers. Of course the effects are not all
good. To achieve this effect the government must pay the subsidy to the
firms and that must come from an increase in taxes, either now or in the
future. So the country must incur a cost in the form of government expenditures.
The final effect, that is the effect on national welfare, is ambiguous.
However it is conceivable that the area given by (h + i + j) may exceed
area (b), in which case, national welfare will rise. Of course, if a different
subsidy level is set, it is also possible that national welfare will fall.
It will depend on the value of the subsidy, and it will vary across every
separate market. In the case that welfare does rise, it will occur because the country
is a large importer. The domestic production subsidy allows the country
to take advantage of it monopsony power in trade. By stimulating domestic
production, the subsidy reduces import demand which pushes the price of
the country's import good down in the world market. In other words, the
country's terms of trade improve. In this way a country can take advantage
of its monopsony power by implementing a domestic policy, such as a production
subsidy to an import competing industry. Note well though that not every
subsidy provided will raise national welfare. The subsidy must be set
at an appropriate level for the market conditions to assure an increase
in national welfare. In general, a relatively small subsidy will achieve
this objective. If the subsidy is set too high, the losses from government
expenditures will exceed the gains to consumers and producers and the
country will suffer national welfare losses. Other domestic policies can also be used to raise national welfare in
the case of a large importing country. Indeed, any policy which restricts
international demand for a product will potentially raise national welfare.
I say "potentially" here because it is necessary to set the policy at
the proper level. The other obvious domestic policy which can achieve
this result is a domestic consumption tax on the imported product. Recall
that a consumption tax is one of the two domestic policies which, when
applied together, substitutes for an import tariff. Since the import tariff
can raise welfare, so can its constituent parts. Summary What follows is a short list of some of the important results from this
section.
International Trade Theory and Policy - Chapter 100-6: Last Updated on 9/9/02
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