Cost differential and welfare effects of interventionist trade policies in oligopolistic international trade

We consider the situation where a foreign firm penetrates a domestic market and a domestic government implements interventionist trade policies to protect domestic producers. This article investigates the impact of such policies on world welfare, which is defined to be the sum of domestic welfare and foreign welfare. As regards interventionist trade policies, we consider not only an output ceiling or capacity constraint but also taxes on the foreign firm and subsidies on the domestic firms. We examine under what conditions the interventionist trade policies achieve the two objectives of protecting the domestic producers and of improving world welfare. It is shown that the cost differential between the foreign firm and the domestic firms plays a crucial role in achieving these two objectives. In particular, an output ceiling and taxes on the foreign firm achieve them only when the foreign firm's marginal cost is considerably higher than the domestic firms' marginal costs, while subsidies achieve them not only when the foreign firm's marginal cost is higher than the domestic firms' marginal costs, but also when the foreign firm's marginal cost is lower than the domestic firms' marginal costs but when the cost differential is relatively small. We also discuss how these results are affected when the domestic market structure changes.