Dumping- Definition, Motives, and Price-Output Determination

What is Dumping?

Dumping means selling goods abroad at a lower price than is charged for them in the home market. Some economists define dumping as selling in the foreign market at a price that is less than even the cost of production. But they do not clearly specify whether the cost of production in this context refers to the average or marginal cost of production. The dumped goods are mostly sold in foreign markets below average but above the marginal cost of production. But it is quite possible to sell the dumped goods above the average, but below the marginal cost of production. It is, therefore, advisable not to define dumping in terms of costs whether average or marginal, because that will unnecessarily complicate our analysis. Dumping may, therefore, be defined as that type of price discrimination where the monopolist sells his product at a lower price in a foreign market than in the home market.

Motives of Dumping:

The monopolist may resort to dumping due to any one of the following motives:

(1) To get rid of surplus production- It is possible that, due to some error in demand estimates, the producer monopolist might produce more output than is necessary for the domestic market. This will result in overproduction. If the monopoly tries to sell the extra output in the domestic market, then he will have to lower the price not only for the extra output but for his entire produce. He may find it more profitable to dispose of the extra or surplus output in a foreign market at a lower price than to sell it at home at a higher price.

(2) To crush rivals in foreign markets- Another motive of dumping may be the monopolist’s desire to crush his rivals out of existence in foreign markets. To achieve this objective, he may sell his product in the foreign markets at a price, which is lower than even his marginal cost of production. Once the foreign rivals are crushed, and the field is clear, he can raise the price again to earn maximum profits even in the foreign markets. 

(3) To reap the advantages of increasing returns- Still another motive of dumping, maybe the monopolist’s desire to reap the advantages and benefits of the law of increasing returns. According to the law of increasing returns, as the monopolist increases his output, the average and marginal costs both decline. But the demand in the domestic market being inelastic, the monopolist will have to reduce the price to an extent greater than the reduction in average cost, if he is to sell the extra output in that market. In addition to that, the monopolist will have to lower the price on all the units to be sold, and not on marginal units, only. Total revenue, and hence his profits, will decline. He will, therefore, find it more profitable to sell the extra or additional output in foreign markets.

(4) To create demand in foreign markets- The monopolist may sell in foreign markets at a lower price than in the home market because he desires to create new demand for his product in those markets. Once the demand for his product is created and his product becomes popular in foreign lands, he may raise the price at a later occasion.

(5) To take advantage of differences in demand elasticity- The monopolist may resort to dumping because the elasticity of demand in foreign markets is higher than at home. He may also resort to it because there are several rivals in foreign markets while there is none at home. It is also possible that foreign consumers are in a position to take to substitutes of his product, whereas domestic consumers are not in that fortunate position. So he can charge a higher price at home than abroad.

Price-Output Determination Under Dumping:

We shall now illustrate with the help of a diagram of price-output determination under dumping.

In the above diagram, we have assumed that the producer is the monopolist only in the domestic market and that he is not the monopolist in the foreign market. The foreign market is perfectly competitive. In Market D, the domestic market, the producer is, as said above, the monopolist. As such, his average revenue curve AR_D slopes downwards. MR_D is his corresponding marginal revenue curve. On the contrary, in the foreign market F, there prevails perfect competition so far as this particular product is concerned. As such, the average revenue curve AR_F takes a horizontal shape. The elasticity of demand for the monopolist’s product is infinite in the foreign market. As happens under perfect competition, the marginal revenue curve (MR_F in this diagram) coincides with the average revenue curve. MC represents the marginal cost curve of the monopolist’s total output. The monopolist has now to decide how much of the total output is he going to produce. For this, he will have to find out where his marginal cost curve cuts the combined marginal revenue curve (of the two markets). The combined marginal revenue curve in this diagram is represented by ATQS. This combined ATQS curve has been obtained by adding on sideways the marginal revenue curve of the foreign market to the marginal revenue curve of the domestic market. To this has been added sideways TQS which is a portion of the marginal revenue curve of the foreign market. ATQS, thus, represents the combined marginal revenue curve of the domestic as well as the foreign market. Now this ATQS curve intersects the marginal cost curve MC at Q. OM is, thus, the total output that the producer-monopolist has to produce for both markets. The question now is: After having produced OM output, how is the monopolist going to allocate it between the domestic and the foreign markets?

As we have already pointed out earlier, the monopolist allocates the toat output between the two markets in such a manner that marginal revenue is the same in both markets. The marginal revenues in both markets can be equalized if the monopolist allocates OH output to the domestic market and HM output to the foreign market. In that case, marginal revenue TH in the domestic market is equal to marginal revenue QM in the foreign market. Not only are the marginal revenues in the two markets equal to each other, but they are also equal to the marginal cost of production QM. Thus, both the conditions for the discriminating monopolist’s equilibrium are fulfilled. He will earn the maximum profit (represented in this diagram by ATQP) by following the above allocational arrangement. As the diagram shows, the price ON_D in the domestic market is higher than the price ON_F in the foreign market. In the domestic market, he sells OH output at ON_D price, and in the foreign market, he disposes of HM output at ON_F price.

While deciding the prices, the monopolist should see to it that the price charged in the foreign market is not unduly low; otherwise, the traders in the foreign markets will purchase the product at the low price, and re-export it to the home country of the monopolist to be sold at the higher price in the domestic market. The monopolist will then be faced with competition from his own product. His main objectives of dumping or price discrimination will be defeated and he shall not be able to earn maximum profits. The condition for the sustenance of dumping, then, is that the difference between the domestic price and the foreign price must be less than the cost of transporting the commodity from the foreign to the home country.