Tariffs and capacity utilization by monopolistically competitive firms

This paper examines the effect of a tariff imposed on a monopolistically competitive (MC) sector on firm output in a 2 × 2 × 2 model with nonhomothetic technology. If the MC sector is capital intensive, then a tariff will improve the terms of trade, lower home firm demand elasticity, but raise firm output relative to foreign firms. If the MC sector is labor intensive, then excess supply for firm output may be decreasing in price, so the tariff may worsen the home country's terms of trade. Home firm demand elasticity falls but firm output rises relative to the partner country. These results qualify conclusions based on single-sector and single-country models.