DERATIONALIZING TARIFFS WITH SPECIALIZED INTERMEDIATE INPUTS AND DIFFERENTIATED FINAL GOODS

Existing analyses of differentiated products suggest that a small tariff must be welfare improving, as a positive terms-of-trade effect and an increase in the number of domestic varieties outweighs the loss of foreign varieties. This result appears to be due to an arbitrary assumption that the intra-sectoral elasticity of substitution in consumption exceeds the inter-sectoral elasticity. This paper demonstrates that complementarity among specialized inputs (or differentiated final goods) implies that a small tariff can derationalize production sufficiently such that the number of domestic inputs/goods falls and welfare is reduced. © 1990.