Optimal tariffs and retaliation with perfect foresight

Gerald Vernon Post

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The naive Cournot and Stackelberg retaliation assumptions were replaced with perfect foresight on the part of all countries involved. Each country maximized some measure of welfare subject to a belief about how the other countries would react to changes in tariffs. The two country, two good world was modelled in partial equilibrium, using consumer and producer surplus as approximations to welfare. The problem was solved within the framework of an infinite horizon dynamic programming model. The five equilibrium points representing perfect foresight were classified into three categories: no retaliation, full retaliation, and opposite retaliation. The optimal tariff levels and resulting welfare were compared for various values of the social discount factor;The perfect foresight problem was also solved for M exporting and N importing countries. The levels of the five possible optimal tariffs were examined as the number of exporters and importers was increased. In most cases, the optimal tariffs were subsidies that rapidly declined to zero (free trade) as the number of countries was increased.

Date: 1983-01-01
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