Network externalities, transport costs, and tariffs

Abstract

This article formulates a reciprocal market model of international duopoly with network externalities to reconsider welfare effects of reductions in transport costs and tariffs. Depending on the magnitude of network externalities, we show two possibilities. One of them, which emerges under strong network externalities, illustrates that freer trade unambiguously improves welfare for any initial level of trade barriers. This finding provides an affirmative evaluation of freer trade.

Keywords:

• network externality
• duopoly
• transport costs
• tariffs

JEL Classifications:

• F12
• L13

Acknowledgments

I am grateful to two anonymous referees for helpful comments and suggestions. Any remaining error is my own responsibility.

Notes

1. See Shy (2001) for a formal definition of network externalities. For recent developments in literature, see, for example, Farrell and Klemperer (2007).

2. While we adopt an oligopolistic model, some predecessors employ a monopolistically competitive model, e.g. Harris (1998), Kikuchi (2002, 2003) and Kikuchi and Ichikawa (2002).

3. We should comment that Krishna (1988) is the first to incorporate network externalities into the models of oligopolistic trade. She makes clear how network externalities affect the effects of unilateral adoption of trade policies.

4. See, among others, Brander (1981) and Brander and Krugman (1983).

5. We allow for negativity of τ (import subsidy) in the tariff case.

6. The second-order conditions are satisfied.

7. Trade gains are ensured in the marginal case in which b + bθ = 1/2 as well.

8. [Wtilde](τ) becomes negatively linear in the special case of b + bθ = 1/2.