Reciprocal Dumping

The reciprocal dumping model of international trade was proposed in Brander and Krugman (1983) and has been extended in many directions since. The model shows how oligopolistic rivalry can serve as an independent explanation for international trade (i.e., aside from comparative cost advantage) and that it can lead to two-way trade in identical products (i.e., intra-industry trade). In this sheet we set out a numerical version of the model. It features linear demand and supply, and firm cost functions exhibiting constant marginal costs and decreasing average costs. The transportation costs are modelled as iceberg type. The user can change any of the demand, cost and transportation parameters of the firms in each country independently. Various graphical devices are implemented in the sheet. Solver is not required.

Model Layout Guide  

The Role of Transportation Costs
In this model the transportation cost is measured using the 'iceberg' approach. We can think of this as meaning that for every unit that is shipped only a fraction arrives at the destination. That fraction is the number in cells D11 (for Home) and D29 (for Foreign). Notice that the cost of shipping is not necessarily the same in both directions. To see what happens as transportation costs rise, decrease the numbers in D11 or D12. You should find that the volume of exports declines. What if transportation costs rise very high? At some point, exports will cease to be profitable. In this model, if the iceberg parameter is 0.40, it will not make sense to export, and the partner country will be a monopoly. On the other hand, if the iceberg parameter is 1, exporting is costless and the result is simply a Cournot duopoly in each country.