Tariffs on Input Trade Margins under Vertical Oligopoly: Theory and evidence

What is the effect of tariffs on the input trade margins when vertically related markets are oligopolistic? To address the question, this paper develops a vertical oligopoly model in which one country specializes in producing a final good while another country specializes in producing an intermediate good by taking into account strategic interactions among firms. We find that, for constant-elasticity demand, a tariff reduction increases the number of trading firms (extensive margin) and average trade value per firm (intensive margin) in the vertically related sectors, raising the intensive margin relative to the extensive margin. To assess the empirical relevance of our theoretical results, we focus on China’s WTO accession which was a large policy change to Chinese firms. We find that a tariff reduction significantly increases both margins in the post-WTO period, though the effect on the extensive margin is much smaller than that on the intensive margin. * We revised this discussion paper with the new title in March 2024. This paper was previously circulated under the title "Tariffs, Vertical Oligopoly, and Market Structure."