A Reappraisal of Strategic Trade Policy
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We investigate the welfare effect of an export subsidy/tax in the “third market” trade model. The conventional wisdom is that an export subsidy increases home welfare in a Cournot setting (Brander and Spencer 1985) and an export tax increases home welfare in a Bertrand setting (Eaton and Grossman 1985). By allowing firms to compete in a Cournot-Bertrand duopoly model where one firm competes in output and the other competes in price, we are able to show that the conventional wisdom is incomplete. Optimal trade policy does not depend simply on whether firms compete in a Cournot or Bertrand type game. It only depends on whether the foreign firm competes in output or price.
KeywordsStrategic trade policy Cournot-Bertrand model
JEL ClassificationsC72 D43 F11 F13
We would like to thank Patrick Emerson, Rolf Färe, Todd Pugatch, Carol Tremblay, and two anonymous referees for helpful comments on an earlier version of the paper.
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