INFORMATION TO USERS This manuscript has been reproduced from themicrofilm master. U M I films the text directly from the original or copy submitted. Thus, some thesis and dissertation copies are in ^ewriter face, while others may be from any type of computer printer. The quality of this reproduction is dependent upon the quality of the copy submitted. Broken or indistinct print, colored or poor quality illustrations and photogr^hs, print bleedthrough, substandardmargins, and improper alignment can adversefy affect reproduction. In the unlikely event that the author did not send UMI a complete manuscript and there are missing pages, these will be noted. Also, if unauthorized copyright material had to be removed, a note will indicate the deletion. Oversize materials (e.g., maps, drawings, charts) are reproduced by sectioning the original, beginning at the upper left-hand comer and continuing from left to right in equal sections with small overlaps. Each original is also photographed in one exposure and is included in reduced form at the back of the book. Photographs included in the original manuscript have been reproduced xerographically in this copy. Higher quality 6" x 9" black and white photographic prints are available foraxsy photographs or illustrations appearing in this copy for an additional charge. Contact UMI directly to order. UMI A Bell & Howell Information C o m pany 300 North Zeeb Road. Ann Arbor.Ml 48106-1346 USA 313,'761-4700 800/521-0600 Order Number 9516982 A linear-quadratic dynamic game approach to estimating market power in the banana export market Deodhar, Satish Y., Ph.D. The Ohio State University, 1994 Copyright ©1994 by Deodhar, Satish Y. All rights reserved. UMI 300 N. Zeeb Rd. Ann Arbor, MI 48106 A LINEAR-QUADRATIC DYNAMIC GAME APPROACH TO ESTIMATING MARKET POWER IN THE BANANA EXPORT MARKET DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Doctor of Philosophy in the Graduate School of The Ohio State University By Satish Y. Deodhar, M.A. ***** The Ohio State University 1994 Dissertation Committee: Approved By Prof. Ian Sheldon Prof. Dennis Henderson Prof. Mario Miranda iviser Department of Agricultural Prof. Stanley Thompson Economics and Rural Sociology Copyright by Satish Y. Deodhar 1994 flïï I 3?4^lltM - =h1(cy^ { ^ ^ o ^ o 3 ® ) "Economics is the most important", says Kautilya. For, both the spiritual good and material well-being depend on it. Arthaéàstra - Kautilya (circa 320 B.C.) TO MY PARENTS 1 1 ACKNOWLEDGEMENTS I would like to express my sincere appreciation and gratitude to Prof. Ian Sheldon for his constant encouragement and guidance. As my "Guru", he has served in many roles, as a mentor, teacher, guide and a counselor. Gratitude is also owed to Prof. Mario Miranda and Prof. Dennis Henderson for their useful suggestions and insights. I am specially thankful to Prof. Perloff of the University of California, Berkeley, some of whose original computer programs have been used in this study. Thanks go to all the members of my supporting cast. Suggestions of Prof. Jones for the static model, Peter Voros's help in mainframe computing, and Jim Dayton's frequent help in my imperfect word-processing is acknowledged. Credit must also go to fellow graduate students, who from time to time provided valuable information, and offered suggestions. Finally, I wish to thank my family, who had to endure the best and the worst in me. My parents, sister and brother-in- law were a source of constant support throughout my graduate program. To my lovely wife, Deepali, I offer sincere thanks for her unshakable faith in me, and her willingness to share with me the vicissitudes of my research endeavor. iii VITA 1985 ................. B.A. (Econ), Gokhalé Institute of Politics and Economics, Puné, India. 1986-88 ............. Sub-Broker, Momsha Financial Consultancy Services, Puné, India. 1989 ................. M.A., Dept, of Economics, The Ohio State University, Columbus, OH. 1988-92 ............. Graduate Teaching Associate, Dept. of Economics, The Ohio State University, Columbus, OH. 1992-94 ............. Graduate Research Associate, Dept. of Agricultural Economics, The Ohio State University, Columbus, OH. PUBLICATIONS Deodhar, S. and Sheldon, I. (1994) "Is Foreign Trade (Im)Perfectly Competitive?: An Analysis of the German Market for Banana Imports," Working Paper # ESO - 2154, The Ohio State University, Columbus: OH. Deodhar, S. and Sheldon, I. (1994) "Estimation of Dynamic Oligopolistic Interaction: The Case of the Banana Export Market," Paper accepted for the Southern Economic Association Conference, November 1994, Orlando: FL. FIELDS OF STUDY Major Field: Agricultural Economics and Rural Sociology _Studies in International Agricultural Trade Minor Fields: Macroeconomics, Labor Economics IV TABLE OF CONTENTS DEDICATION ...................... il ACKNOWLEDGEMENTS ...................................... ill VITA ................................................... iv LIST OF TABLES ......................................... vii LIST OF FIGURES ......................................... viii CHAPTER PAGE I. INTRODUCTION ................................ 1 1.1. Traditional Trade Theories .............. 1 1.2. The New Trade Theories ................. 3 1.3. Estimation of Market Power Using Dynamic Games .................... 5 1.4. Plan of Dissertation .................. 7 II. SYNTHESIS OF INDUSTRIAL ORGANIZATION AND INTERNATIONAL TRADE .................... 10 2.1. Origin of the NTTs .................... 10 2.2. Domestic Markets and Foreign Competition 13 2.3. Intra-Industry Trade .................. 19 2.4. Trade Policy Issues ................... 32 2.5. The Litmus Test ........................ 39 III. STATIC MODELS OF MARKET POWER ESTIMATION .... 41 3.1. Traditional Approach .................. 41 3.2. Modern Approach ....................... 45 3.3. Summing Up ............................. 62 IV. DYNAMIC MODELS OF MARKET POWER ESTIMATION ... 65 4.1. Conjectural Variations Approach ........ 65 4.2. Game Theory and Oligopoly ............. 72 4.3. Dyneunic Games Approach................. 86 4.4. Retrospection......................... 100 V. THE BANANA EXPORT MARKET ............ 103 5.1. Historical Background .................. 103 5.2. Structure of the Banana Industry ...... 106 5.3. Motivation for the S t u d y ............... 108 5.4. Methodology ............................ 112 VI. EMPIRICAL PROCEDURE ......................... 115 6.1. Data Description and Sources .......... 115 6.2. The Static Model ....................... 117 6.3. The Dynamic Model ...................... 125 VII. CONCLUDING DISCUSSION ....................... 142 7.1. Inference and Policy Implications ..... 142 7.2. Limitations and Future Direction ...... 149 APPENDICES A. Data .................................... 152 B. Restrictions Obtained From the Open-Loop First Order Condition ....... 154 C. Restrictions Obtained From the Feedback First Order Condition ........ 158 D. Solving the Restrictions to Obtain Values of V and Ô ...................... 161 E. Glossary ............................... 163 BIBLIOGRAPHY ...................................... 165 VI LIST OF TABLES TABLE PAGE 3.1. Estimates of Lerner's index (L) .............. 63 6.1. Description of Variables ..................... 118 6.2. Estimation of the Static Model ............... 121 6.3. Bootstrapping of the Static Model ............ 123 6.4. Banana Export Adjustment (Markov) Equation ... 131 6.5. Classical Estimates of Dynamic Model.......... 133 6.6. Bootstrapping Dynamic Model .................. 135 6.7. The Distribution of V ........................ 136 6.8. Hypothesis Testing for Bootstrapped V & Ô .... 141 V l l LIST OF FIGURES FIGURES PAGE 2.1. Import competition and domestic pricing... .. 15 2.2. Competitive export market and domestic pricing 17 2.3. Intra-industry trade ........................ 24 2.4. Production Pattern of a MNC at home and abroad 29 2.5. VERs and the resultant Nash & mixed strategy equilibria .................................. 38 3.1. Parallel shift of the demand c u r v e .... 50 3.2. Rotation of the demand curve ................ 52 4.1. Cournot-Nash and Collusive payoffs .......... 77 4.2. Closed-loop and open-loop strategies ........ 84 4.3. Static and dynamic reaction functions ....... 92 6.1. Distribution of X ............................ 124 6.2. Flowchart of the dynamic model .............. 126 6.3 Distribution of Vs .......................... 138 6.4. Distribution of 6s .......................... 139 6.5. Convergence of and Vf ..................... 140 viix CHAPTER I INTRODUCTION 1.1 Traditional Trade Theories The notion that societies benefit from exchange of goods and services is a very old one. Smith (1776) wrote in The Wealth of Nations, that the division of labor which reduces unit cost of production, is a consequence of a certain propensity in human nature; the propensity to truck, barter and exchange one thing for another. He advocated the concept of absolute advantage which meant that a country will specialize in the production and export of those goods in which it incurs lower opportunity cost compared to the other country. Four decades later, Ricardo (1817) expanded his idea and proposed a theory that explained the reason for and pattern of trade between any two nations. In his treatment, trade occurs due to differences in technology between two nations and each one specializes in the production and export of good that it produces at lower opportunity cost under autarky. His important contention was that,