Lobbying for Car Import Taxes: In exercise 26.8, we investigated the incentives of existing car companies to deter entry of new companies through lowering of car prices. When the potential new car company is a foreign producer that wants to enter the domestic car market, an alternative way in which such entry might be prevented or softened is through government import fees and/or import tariffs.
A: Suppose throughout that the foreign car company has product characteristic 0.5 while the domestic companies are committed to the maximally differentiated product characteristics of 0 and 1 in the Hotel ling model.
(a) Suppose first that the government requires the foreign car company to pay a large fee for the right to import (as many cars as it would like) into the domestic market. If the government makes any revenue from this policy, will it have any impact on the car market when all decisions are made simultaneously?
(b) For a given fee F, why might the domestic car industry expend zero lobbying effort on behalf of this policy? Why might it expend a lot?
(c) Suppose domestic firms can collude on setting a price in anticipation of entry (and can credibly commit to that price). True or False: There is now a range of F under which the foreign company does not enter when it would have entered given conditions in (a). (Assume that if entry occurs, the industry plays the simultaneous Nash pricing equilibrium.)1
(d) Under the conditions in (c), does your answer to (a) change? Is there now a range of fees under which the foreign company does not enter the market but domestic companies lobby for higher fees?
(e) Suppose that instead the government imposes a per-unit tax t on all imported cars. Compared to what would happen in the absence of any government interference, how do you think domestic and foreign car prices will be affected?
(f) How will market share of domestic versus foreign cars differ under the tariff?
(g) Suppose the government imposes the lowest tariff that results in no foreign cars being sold. Do you think that domestic car companies can now charge the same price they would if foreign cars were prohibited from the domestic market outright?
(h) Based on your answer to (g), might domestic firms lobby for higher import tariffs even if no cars are imported at current tariff levels?
B: Consider again, as in exercise 26.8, the version of the Hotel ling model from Section 26B.2 with the domestic car companies having settled at the equilibrium product characteristics of 0 and 1 on the interval [0, 1]. Suppose again that α = 12,000 and c = 10,000. Assume throughout that domestic companies cannot change their product characteristics.
(a) If you have not already done so, do parts (a) through (e) of exercise 26.8.
(b) Suppose that the government required the foreign company to pay a fee F in order to access the domestic market (without placing any restrictions on how many cars can be imported). Suppose there is no way for domestic firms to credibly commit to prices prior to the foreign firm deciding whether or not to enter. What is the lowest F that the domestic industry would lobby for assuming there are no other fixed entry costs? Would lobbying efforts be more intense for imposition of a higher fee?
(c) How would your answer change if the domestic firms could credible commit to a price prior to the foreign firm deciding on whether or not to enter? (Assume that the domestic firms agree to announce the same price.) For what range of F will domestic firms push to increase F? (Note: It is helpful to reason through (f) and (g) of exercise 26.8 prior to attempting this part.)
(d) Next, suppose that instead the government imposed a per-unit tariff of t on all car imports. Treat this as an increase in the marginal cost for importing firms—from c to (c + t). Derive thee equilibrium prices charged by domestic firms and importing firms as a function of t. (Follow the same steps as in B(c) and (d) of exercise 26.8.) What can you say about the tax incidence of this tariff?
(e) Derive the market share for firm 1 (and thus also firm 2) as a function of t. What level of t will restrict foreign imports to the same level as an import quota that limits foreign cars to one third of the market (assuming no fixed entry costs)?
(f) What is the lowest level of t = t that guarantees no foreign cars will be sold in the domestic market (assuming no fixed entry costs)?
(g) What prices will domestic car companies charge if t is set to t?
(h) Explain why setting t differs from the case where the import of foreign cars is prohibited.
(i) What level of t > t is equivalent to prohibiting the entry of the foreign firm?