Preferential Trade Agreements, Market Power, and Product Differentiation

Preferential Trade Agreements, Market Power, and Product Differentiation

Preferential trade agreements (PTAs) usually result in increased trade amongst member countries and lower prices within the PTA. Thus the markets are assumed to be “more competitive” because lower prices are taken to imply “decreased market power” due to a reduction in price-cost margins. In this paper we empirically examine the relationship between changes in market power and product differentiation within the context of a duopoly framework with restricted entry. Using industry level trade data from the EEC we show that the formation of a PTA may increase the market power of PTA-exporters and lower the market power of non-PTA exporters. In addition, we show that these market power effects are more pronounced for less differentiated products.