Endogenous Vertical Structure and Trade Policy in an Import-competing Market with Fulfilled Expectations

Abstract

This paper examines the endogenous determination of vertical organizationstructure (i.e., vertical integration or separation) when an optimal import tariff is implemented in an import-competing market, where one home firm and one foreign firm engage in price competition under network externalities. The optimal import tariff is higher when the foreign exporting firm is vertically separated than when it is integrated. If firms commit to vertical organization before trade policy, then the foreign firm chooses vertical integration but home firm chooses vertical separation (integration) if network externalities are weak (strong). In addition, the behavior of home firm in a relatively low network externalities is inconsistent with social optimum.

JEL Classification: F12, F13, L13