Relative efficiency of specific and ad-valorem tariffs in a model of monopolistic competition

The relative efficiency of ad-valorem and specific tariffs is still an active debate in the international trade literature. Contrary to the general belief about the ad-valorem tariff being superior under various imperfectly competitive market settings, it is shown that the specific tariff generates more welfare under monopolistic competition. We argue that this result is not general. If we follow the empirical evidence that firms use variable mark-ups and use a utility function that allows for it, we find that the ad-valorem tariff is more efficient when consumers’ love for variety is low. The relative efficiency overturns to the specific tariff as consumers’ love for variety increases.