Welfare Effects Of Industrial Policies Under Asymmetric Oligopoly And Endogenous Quality

Author

Joseph Akee Toe, Southern Illinois University CarbondaleFollow

Date of Award

1-1-2009

Degree Name

Doctor of Philosophy

Department

Economics

First Advisor

Lahiri,Sajal

Abstract

This dissertation investigates the impact that a duopoly of a multinational firm and local firm has on a closed economy as they engage in Bertrand competition involving quality and price. It answers the question: Does helping a minor firm reduce welfare? Using a different framework than the existing literature, I examine the following: 1. The welfare effect of a reduction in the R\&D cost parameter induced by ``help'' from the government to one of the firms within a closed economy. 2. The effects of government policy instruments (taxes or subsidies) on welfare considering different ownership of the firms and trade pattern - closed economy and export-oriented economy as government institutes a unilateral policy, discriminatory policy, or non-discriminatory policy. 3. How marginal cost of production of the local firm affects welfare within a closed economy when all consumers are either served or partially-served. In chapter 1, we provide a review of past literature that have studied the endogenous choice of quality by firms and describe how this dissertation is organized. In chapter 2, we examine effect on national welfare from competition in quality between a multinational firm and a local firm operating in a vertically differentiated oligopolistic industry given their strategic use of R\&D costs without any possibility of spillover effects. The model assumes that the multinational firm produces high quality product and the local firm produces low quality product. Both firms have zero marginal production cost. Assuming a closed-economy, we determine the effect of a change in the local firm's R\&D cost parameter on the endogenous variables (prices and qualities) as well as national welfare. We found that a reduction in the cost parameter of the local firm do increase national welfare. Chapter 3 extends the work of Chapter 2. It investigates the incentives to a government for instituting strategic trade policy (unilateral, discriminatory or non-discriminatory) mechanism that would induce R\&D within the duopoly of a multinational and local firms and thereby promote national welfare, under varying assumptions with respect to the ownership structure of the firms and their trade patterns. It determines which policy mechanism would be socially optimal to strategically affect the quality of the target firm (local). We find under an open-economy situation when government policy is unilateral, the optimal policy tool to pursue is a subsidy for the local firm. When the economy is partially-closed, it is optimal for the government to tax the local firm. Besides, under a discriminatory policy mechanism, it is best for government to subsidize the local firm and tax the foreign firm when both export to a third country. However, if both sell to a third country, but profit is retained in the domestic economy, it becomes optimal for the government to tax the local firm. Under a non-discriminatory policy by government when the firms operate within an open-economy, the optimal tool is a tax policy for government that affects both firms. Moreover, when the firms operate within a partially closed-economy, the optimal policy is also a tax policy on both firms. Whereas, given a non-discriminatory policy under a closed-economy framework, it is optimal for the government to subsidize the firms. As a result, these mechanisms by government do promote social welfare as well as correct any distortion that might result into making the multinational firm having a significant market power within the industry. In Chapter 4, we relax the assumption of Chapter 2 that the firms have zero production cost. The duopoly is considered to operate under the condition that one of the firms (local firm) has a production cost disadvantage. The firms are assumed to served the entire market. Hence, the firms compete within a fully covered market scenario. Considering a variable unit (constant marginal) cost of production of the local firm, we determine the effect of an increase in production cost of the local firm on national (total) welfare. We find that within a closed-economy, due to strategic substitutability of the products of both firms, an increase in the marginal cost of production by the local firm would bring about reduction in national social welfare. Chapter 5 continues our welfare analysis. It assumes the firms have asymmetric production costs. The cost of production depends on investment in R\&D to produce an output of quality, $q_i$. Now, we do not associate the output quality to a specific firm in the beginning of our analysis. Notwithstanding, we assume the firms are required to meet a minimum quality standard in the industry. Then, we seek to find the effect of the marginal cost of production of the local firm on national welfare. We find unlike previous chapters, an increase in marginal cost of production by the local firm results into increase benefits to consumers. Hence, national social welfare is improved (positive).