International competition, growth and welfare

Opening up to trade implies a change in market structure as firms are exposed to new competitors. If foreign and domestic firms produce close substitutes, their interaction in the product market forces prices below the monopolistic level. Demand shifts from monopolistic to oligopolistic varieties and incentives to develop new varieties are reduced. The changing market structure constitutes a market failure as competition becomes asymmetric. If the scale and the intensity of competition are large, trade will reduce the welfare level even below the autarky level. Temporary, declining tariffs on all imports and permanent tariffs on oligopolistic varieties are instruments to improve welfare.