Discriminating Monopoly, Forward Markets and International Trade

Recent empirical studies (see e.g. Kravis and Lipsev [1977, 1978], Isard [1977], Aspe and Giavazi [1982]) demonstrate that there are notable divergencies between domestic and export prices. This empirical evidence suggests that the law of one price is systematically violated. Kravis and Lipsey [1977, p. 155] argue that "many firms involved in international trade, particularly manufacturers, are in the position of a discriminating monopolist faced with separate markets, each characterized by a different demand elasticity". A model which explicitly allows for price discrimination has been used by several authors (see for example Aspe and Giavazi [1982], Ethier [1982], Katz, Paroush and Kahana [1982] and Tarr [1979]). Katz, Paroush and Kahana [1982] (hereafter KPK), used a model of a price discriminating firm which operates under price uncertainty, to investigate its optimal level of output and sales in the two markets. The main assumption made in KPK [1982] is that the firm determines its level of output and the allocation of sales between the two markets before the resolution of uncertainty. Furthermore, no forward markets were available to this firm. In this paper, we analyze a price discriminating firm which sells its produce both in the domestic and on world markets under either exchange rate uncertainty or foreign price uncertainty. This firm is a monopoly in the domestic market but a price-taker on the world market