Vertical Foreclosure and International Trade Policy

Abstract

International differences in the cost of production of a key intermediate product can mean that a domestic firm is dependent on supplies from a foreign vertically integrated firm. This paper considers the incentives for the foreign firm and foreign country to supply the domestic firm when the firms compete in a Cournot or Bertrand market for the final product. The vertical supply decision is significantly affected by domestic supply conditions for the input and a domestic tariff on final product imports. Optimal policy by the exporting country may require a tax on both exports, or a subsidy on both exports.