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Strategic Subsidy Policies with Endogenous Choice of Competition Mode

Lim, Seonyoung and Choi, Kangsik (2014): Strategic Subsidy Policies with Endogenous Choice of Competition Mode.

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Abstract

We investigate government subsidy policies in which a home firm and a foreign firm choose to strategically set prices or quantities in a third market. We show that even though each firm can earn higher profits under Cournot competition than under Bertrand competition regardless of the nature of goods, choosing Bertrand competition is the dominant strategy for both firms. This leads each firm to face a prisoners' dilemma in equilibrium. We also show that from the aspects of governments under subsidy regime, Cournot competition is more efficient than Bertrand competition when the goods are substitutes, and vice versa when the goods are complements. For this, from the aspects of firms, the Cournot equilibrium could be Pareto superior (inferior) with government's intervention of subsidy policy when the goods are substitutes (complements). Thus, the conflict of interests between governments and firms occur when goods are complements. Hence, our result may justify that when the goods are substitutes, a general principle is that the incentive to intervene in the international trade is greater under Cournot competition than under Bertrand competition.

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