taxes and tariffs. The reason for this outcome is mainly the terms of trade
effect. Since less developed regions rely relatively more on industrial imports
also the impact of industrial tariffs is relatively stronger. And by playing the
Nash-game the stronger player maintains its advantage also in equilibrium.
5 Maximizing welfare under cooperation
Looking to reality falling transport as a result of technological progress are
accompanied by falling trade barriers almost all over the world. In the ma-
jority of cases these falling trade barriers are a result of negotiations between
participating countries. The fact that negotiations are necessary indicates
that welfare gains are not the automatic consequence of unilateral trade cost
reductions. In this sense, the aim of this section is an analysis of the welfare
consequences if both regions cooperate to maximize aggregated welfare.
Maximizing aggregated real income can be written formally as:
max
Ti,TaTaTa
Y Y *
(1 - TA)Y-1P^' + (1 - TA)Y-1P*γ
(13)
with Y defined in (7). Again, partial derivatives have to be set to zero (cf.
appendix) to get for the optimal agricultural tax rate the already known
result of:
TA,θpt = TA,Opt = σ. (14)
For the optimal tariffs an analytical expression cannot be derived. Instead,
optimal tariffs are the result of the following non-linear equation system:
γθ*l +pγP*1-σ-γ - 1 - σTι
σ - 1 1 - TI
(1-γ)P*1-σ+γ(1-L)
γσLΘ* '
σ - 1 _
(15)
YΘ(1-L). p,γ pι-σ-γ 1-σTI*
σ - 1 + P P - T-T*
(1-γ)P1-σ+γL
γσ(1- L)Θ
σ - 1
0.
Figure 3 shows the numerical solution to this system where the left graph dis-
plays optimal domestic tariffs and the right graph the percental real income
gain compared with the no-cooperation Nash-equilibrium of (12).
12
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