Abstract
This paper examines the consequences of vertical integration with transfer pricing for the rivalry between duopoly firms in an international environment, using the (noncooperative) Nash equilibrium to determine the output equilibrium. Trade policy incentives resulting from vertical integration in one country, focusing on export subsidy, profit tax rate, and attitudes towards transfer pricing in that country, are analyzed. Without the transfer price penalty schema, a government can use either the subsidy or the tax rate to affect the outcome of a Cournot game. With the schema, introducing the interior solution to the transfer price, the optimal policy involves the effective role of both instruments.
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