Welfare–Balanced International Trade Agreements

Filipe Martins (), Alberto A. Pinto and Jorge P. Zubelli
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Filipe Martins: Centro de Matemática, Universidade do Porto—CMUP, Rua do Campo Alegre 687, 4169-007 Porto, Portugal
Alberto A. Pinto: INESC TEC—Instituto de Engenharia de Sistemas e Computadores, Tecnologia e Ciência e Departamento de Matemática, FCUP—Faculdade de Ciências, Universidade do Porto, Rua do Campo Alegre 687, 4169-007 Porto, Portugal
Jorge P. Zubelli: Mathematics Department, Khalifa University, Abu Dhabi 127788, United Arab Emirates

Mathematics, 2022, vol. 11, issue 1, 1-20

Abstract: In this work, we consider a classic international trade model with two countries and one firm in each country. The game has two stages: in the first stage, the governments of each country use their welfare functions to choose their tariffs either: (a) competitively (Nash equilibrium) or (b) cooperatively (social optimum); in the second stage, firms competitively choose (Nash) their home and export quantities under Cournot-type competition conditions. In a previous publication we compared the competitive tariffs with the cooperative tariffs and we showed that the game is one of the two following types: (i) prisoner’s dilemma (when the competitive welfare outcome is dominated by the cooperative welfare outcome); or (ii) a lose–win dilemma (an asymmetric situation where only one of the countries is damaged in the cooperative welfare outcome, whereas the other is benefited). In both scenarios, their aggregate cooperative welfare is larger than the aggregate competitive welfare. The lack of coincidence of competitive and cooperative tariffs is one of the main difficulties in international trade calling for the establishment of trade agreements. In this work, we propose a welfare-balanced trade agreement where: (i) the countries implement their cooperative tariffs and so increase their aggregate welfare from the competitive to the cooperative outcome; (ii) they redistribute the aggregate cooperative welfare according to their relative competitive welfare shares. We analyse the impact of such trade agreement in the relative shares of relevant economic quantities such as the firm’s profits, consumer surplus, and custom revenue. This analysis allows the countries to add other conditions to the agreement to mitigate the effects of high changes in these relative shares. Finally, we introduce the trade agreement index measuring the gains in the aggregate welfare of the two countries. In general, we observe that when the gains are higher, the relative shares also exhibit higher changes. Hence, higher gains demand additional caution in the construction of the trade agreement to safeguard the interests of the countries.

Keywords: international trade; international duopoly; tariff game; prisoner’s dilemma; social optimum; welfare; trade agreements (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2022
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