Parameters: γ = 0.5, σ = 4
Figure 3: Domestic optimal tariffs and real income gain under cooperation
At the symmetric equilibrium (L=0.5) all optimal tariffs are zero while to
the right and to the left optimal tariffs are becoming positive and negative,
respectively. This result is mainly a consequence of the trade costs and the
corresponding different price levels in both regions. The more developed a
region is, the lower the price level and from this perspective rent creating
tariffs improve welfare by more in the developed region than they reduce
income in the poorer region. From the perspective of the less developed
region argumentation is exactly opposite. Although import subsidies reduce
domestic welfare, foreign welfare compensates this loss by additional earnings
of the exporting firms. Furthermore, the lower the trade costs the smaller
are the corresponding tariffs. In case of full integration with zero trade costs
optimal tariffs are even zero and the corresponding curve in figure (3) overlaps
the x-axis. Thus, only if trade costs differ from zero the home market effect
can be existent and optimal tariffs of (15) maximize aggregated welfare.
Concerning the welfare gain (right graph) the interesting results arrives
that a region my gain by cooperation only if its level of development is
high enough, more precise if L > LC . Because of symmetry both regions
gain only if LC < L < 1 - LC . As in the non-cooperation case LC shifts
leftwards as integration proceeds such that corresponding losses of the less
developed region melt away. Thus, welfare gains in both regions as a result of
cooperation are the more likely, the less unequal regions are and the further
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