Welfare-Enhancing, Trade-Restricting Collusion in Geographically Separated Markets with Di¤erentiated Goods

This paper examines a di¤erentiated product duopoly operating in two geographically sepa-rate markets. Firms operate a single production facility each; facilities are located in di¤erent markets, but \u85rms can supply both markets from their respective facility. Shipping across mar-kets is costly; thus, every \u85rm has a cost advantage in its home market. Consumers treat the two products as horizontally di¤erentiated substitutes and their preferences are identical in both markets. In the non-cooperative equilibrium, each \u85rm has a smaller market share and mark-up in the away market. The asymmetric mark-up leads to a market distortion, with more consumers than is socially optimal purchasing the imported good. Collusion between the two \u85rms partially mitigates this distortion by reducing cross-hauling, resulting in higher aggregate welfare. Our model has implications for public policy, especially when the two markets are di¤erent political jurisdictions. In the absence of a cartel, governments can replicate the cartels market allocation through a system of tari¤s and subsidies, chosen in a way that raises both consumer welfare and rm pro\u85ts