A RISK AVERSE PRICE-SETTING MONOPOLIST IN A MODEL OF INTERNATIONAL TRADE

Abstract

We construct a partial equilibrium model of a risk averse monopolist who faces an uninsurable uncertain foreign demand and a constant marginal cost, and makes an ex-ante production plan, committing ex-post to the ex-ante price. Optimal government intervention is considered when the good is only exported and income risk aversion differs for the representative consumer and the monopolist. If both agents are not too risk averse, or are identically so, the government should not intervene. If either or both agents are sufficiently risk averse, we find that a production tax will be optimal when the monopolist is more risk averse than the consumer. There is also a sensible range of parameter values for which the government will be indifferent between taxing or subsidising the monopolist. If the good is consumed domestically, the normal monopoly distortion adds a force for a subsidy.