Pareto Improvements To Free Trade In An Infinitely Repeated Dynamic Game

Abstract

In an infinitely repeated intraindustry trade game governments improve on the static prisoners dilemma outcome of the Brander and Spencer (1985) trade policy.  When firms collude as joint monopolist governments’ reach the Pareto frontier of their feasible and individually rational set (FIRS) using a policy of free trade.  Free trade and collusion will place firms on the Pareto frontier of their effective feasible and individually rational set (EFIRS).  Without collusion free trade forces governments and firms inside their respective FIRS and EFIRS.  We demonstrate that without collusion governments return to the Pareto frontier of their FIRS only when taxing exports.