International Trade Policy towards Monopoly and Oligopoly*

Abstract

The Working Paper Series seeks to disseminate original research in economics and finance. All papers have been anonymously refereed. by publishing these papers, the banco de españa aims to contribute to economic analysis and, in particular, to knowledge of the spanish economy and its international environment.The opinions and analyses in the Working paper series are the responsibility of the authors and, therefore, do not necessarily coincide with those of the banco de españa or the eurosystem.The banco de españa disseminates its main reports and most of its publications via the inTerneT at the following website: http://www.bde.es.reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged. This paper highlights the importance of product differentiation and endogenous r&d in determining the optimal r&d policy, in a model where investment in cost reducing r&d is committed before firms compete in a differentiated-goods third-country export market. R&D is always taxed in oligopolies for high degrees of product differentiation. For lower degrees of product differentiation the duopoly is subsidized or the government remains inactive. in contrast, the monopoly is always subsidized. The government with a duopoly may be active or inactive depending on the degree of product differentiation. Thus, we may observe a reversal in the sign of the optimal r&d policy if the degree of product differentiation changes or, alternatively, if there is a change in the number of firms. Similar qualitative results hold if trade policy uses output subsidies, instead of r&d promotion.

Strategic Investment Subsidies under Asymmetric Oligopoly

“…We show that if firms produce homogeneous goods or symmetrically differentiated goods, a change in the number of rival firms has no specific effect on the direction of the optimal unilateral policy for the home country in which a single firm is located. This result confirms the finding by previous studies such as Dixit () and Kujal and Ruiz (). In contrast, if firms produce asymmetrically differentiated goods, the optimal unilateral investment subsidy may be sensitive to the change in the number of rival firms.…”

“…The first part of Proposition concurs with results shown by Dixit () for the case of a single‐stage Cournot competition and Kujal and Ruiz () for the case of R&D subsidies on cost‐reducing R&D. Although the sign of the optimal unilateral policy remains the same, its level will be affected by a change in the number of foreign competitors. The second part of the proposition proves the possibility of policy reversal that arises from the change in number of foreign competitors.…”

“…It can occur only if the good is asymmetrically differentiated. Note that, unlike Kujal and Ruiz (), a policy reversal can occur even for a country with a single domestic firm.…”

“…However, the foreign merger does not alter the sign of the optimal trade policies . In contrast, Kujal and Ruiz () show that for a certain degree of product differentiation a country in which two firms are located subsidizes R&D of local firms if there are also two firms in the rival country but taxes R&D if a single firm is located in the rival country. The intuition for this policy reversal is that R&D policy produces conflicting effects.…”

“…The literature on mergers and trade policy follows Dixit () to investigate linkages between mergers of firms and the optimal trade policy of exporting and/or importing countries (Collie, ; Cowan, ; Head and Ries, ; Huck and Konrad, ; Kujal and Ruiz, ; Saggi and Yildiz, ) . A merger of foreign firms affects the level of an optimal import tariff by an importing country (Cowan, ; Saggi and Yildiz, ), an optimal combination of an import tariff and a production subsidy by the competing domestic country (Collie, ), and optimal export subsidies by exporting countries (Huck and Konrad, ).…”