Profit-raising entry under oligopolistic trade with endogenous input prices

Abstract

Firms which face the threat of import competition from foreign rivals are conventionally seen as favouring import protection. We show that this is not necessarily the case when domestic firms’ input prices are determined endogenously. In a framework where the input price is determined through contracting with an upstream agent, which could be an input supplier or a labour union, the relationship between a domestic downstream firm's profits and the number of foreign competitors depends on trade costs and the curvature of the demand function. If trade costs are sufficiently high, an increase in the number of foreign entrants can raise the profits of a downstream firm in a home market characterised by Cournot competition. For any concave and linear demand function and for any demand function which is not ‘too convex’, this occurs due to the upstream agent moderating its input price allowing downstream firms to increase profits. For sufficiently convex demand functions, on the other hand, profit-raising entry still occurs, albeit through a substantively different mechanism, and depending upon the extent to which an increase in the input price is passed on to the final consumer.