Capacity Constraints, Collusion, and Trade Liberalization

This paper studies the impact of a decline in trade costs on cartel formation between foreign and domestic firms. In a model that endogenizes the cartel formation between heterogeneous firms in their capacity endowments, the paper investigates how the decrease in trade costs affects the cartel composition and hence the equilibrium price. Assuming a non-all-inclusive cartel, the model shows that foreign firms are more encouraged to become cartel members. The price prevailing on the market, following trade liberalization, depends on the capacity distribution of foreign firms. If they are large enough, the price would increase after openness. When they are sufficiently small, the price falls with liberalization. In such a framework, trade may be welfare-reducing.