Strategic trade policy under isoelastic demand and asymmetric production costs

Abstract

We demonstrate that whether a good of a rival firm is a strategic substitute or a strategic complement is endogenously determined when the market inverse demand is hyperbolic. The relative competitiveness, which is expressed by the ratio of firms’ marginal costs, is the key factor. We derive optimal trade policies, which are dependent upon the firms’ form of strategic action. In particular, it is shown that if the home firm is relatively more efficient (inefficient) than the foreign rival, then it regards the rival’s choice variable as a strategic complement (substitute) and thus the optimal policy recommendation for the home government is to impose an export tax (to give an export subsidy) to the home firm.