Please use this identifier to cite or link to this item:
Campolmi, Alessia
Fadinger, Harald
Forlati, Chiara
Year of Publication: 
Series/Report no.: 
MNB Working Papers 2010/6
We study trade policy in a two-sector Krugman-type trade model with home market effects. We conduct a general analysis allowing for three different instruments: tariffs, export taxes and production subsidies. For each instrument, we consider unilateral trade policy without retaliation. When carefully disentangling the different effects that determine policy makers' choices and modeling general equilibrium effects of taxes/tariffs, we find - contrary to the results of previous studies - that production subsidies are always inefficiently low and driven by the incentives to improve the (welfare relevant) terms of trade. In the cases of tariffs and export taxes results depend crucially on whether the free trade allocation is efficient. When starting from an allocation that is distorted because of monopolistic competition, the home market effect (and in the case of export taxes also the desire to correct for the monopolistic inefficiency) induces policy makers to set a tariff (an export subsidy). However, when monopolistic distortions are corrected, terms of trade effects dominate the choice of trade policy and lead to an import subsidy (an export tax).
home market effect
terms of trade
tariffs and subsidies
Document Type: 
Working Paper

Files in This Item:
702.02 kB

Items in EconStor are protected by copyright, with all rights reserved, unless otherwise indicated.