The Economics Of Dumping
What is dumping?
Dumping is a form of price discrimination across borders. Price discrimination is the practice of charging different customers different prices for the same or similar products/services. For example you might pay €90 per night for a hotel room and another person €60 per night for the same grade of room. The hotel uses pricing models that may be based on how you booked your room (internet vs. travel agent) or your country of origin (Germany vs. UK). These pricing models may indicate that one group of people are willing to pay more than another for the same product.
Price discrimination is an important political issue in world trade. If price discrimination results in foreigners being charged less that the home country consumers, economist call this dumping. Many people see the practice as unfair.
For dumping to occur two conditions need to be met. (1)The industry must be imperfectly competitive -meaning that firms have price setting power. (2) The markets must be segmented so that it is not easy for home country consumers to purchase product intended for foreign markets.
Is dumping unfair? An example
Your company sells 1000 widgets at home and 100 abroad. The price for home goods is €20 per widget and €15 per widget abroad. It seems logical that pushing for more domestic sales will lead to greater profits than an equal increase in foreign sales.
However, to expand your sales you may need to reduce your price by €0.01. This means that the increase in revenue of one extra widget sold would be €19.99. However, you will almost certainly have to reduce the price of all the widgets to €19.99 – not just the 10,001st. This will reduce the total receipts for the 10,000 widgets by €10. Therefore, the marginal revenue for selling one extra widget will be €9.99 not €19.99.
Let’s look at the foreign sales. If you reduced the price by €0.01 you would receive only and extra €14.99 per extra widget. However, the impact of the price reduction on the revenue of the original 100 would be €1. This means your margin revenue on increased exports would be €13.99. In this case it would be more profitable to push for increased foreign sales than domestic sales.