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Strategic Trade and Delegated Competition

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  • Miller, Nolan

    (Harvard U)

  • Pazgal, Amit

    (Washington U, St Louis)

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    Abstract

    Strategic trade theory has been criticized on the grounds that its predictions are overly sensitive to modeling assumptions. For example, Eaton and Grossman (1986) show that Brander and Spencer's (1985) seminal result – i.e., when firms compete by setting quantities the optimal policy involves governments subsidizing their domestic industries – is reversed if the firms compete by setting prices. Applying recent results in duopoly theory, this paper considers three-stage games in which governments choose subsidies, firms' owners choose incentive schemes for their managers, and then the managers compete in the product market. We show that if firms' owners have sufficient control over their managers' behavior, then the optimal strategic trade policy does not depend on whether firms compete by setting prices or quantities. In a linear-demand model in which managers are compensated based on a linear combination of their own firm's profit plus a (possibly negative) multiple of the rival firm's profit, the optimal policy is to subsidize if goods are substitutes and tax if the goods are complements.

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    Bibliographic Info

    Paper provided by Harvard University, John F. Kennedy School of Government in its series Working Paper Series with number rwp02-042.

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    Date of creation: Oct 2002
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    Handle: RePEc:ecl:harjfk:rwp02-042

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    References

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    1. Leonard Cheng, 1985. "Comparing Bertrand and Cournot Equilibria: A Geometric Approach," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 146-152, Spring.
    2. Orlando I. Balboa & Andrew F. Daughety & Jennifer F. Reinganum, 2004. "Market Structure and the Demand for Free Trade," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(1), pages 125-150, 03.
    3. Krugman, Paul R, 1993. "The Narrow and Broad Arguments for Free Trade," American Economic Review, American Economic Association, vol. 83(2), pages 362-66, May.
    4. Neary, J. Peter, 1994. "Cost asymmetries in international subsidy games: Should governments help winners or losers?," Journal of International Economics, Elsevier, vol. 37(3-4), pages 197-218, November.
    5. Jonathan Eaton & Gene M. Grossman, 1983. "Optimal Trade and Industrial Policy Under Oligopoly," NBER Working Papers 1236, National Bureau of Economic Research, Inc.
    6. Paul Klemperer & Margaret Meyer, 1986. "Price Competition vs. Quantity Competition: The Role of Uncertainty," RAND Journal of Economics, The RAND Corporation, vol. 17(4), pages 618-638, Winter.
    7. Fershtman, Chaim & Judd, Kenneth L, 1987. "Equilibrium Incentives in Oligopoly," American Economic Review, American Economic Association, vol. 77(5), pages 927-40, December.
    8. James A. Brander & Barbara J. Spencer, 1984. "Export Subsidies and International Market Share Rivalry," NBER Working Papers 1464, National Bureau of Economic Research, Inc.
    9. Fumas, Vicente Salas, 1992. "Relative performance evaluation of management : The effects on industrial competition and risk sharing," International Journal of Industrial Organization, Elsevier, vol. 10(3), pages 473-489, September.
    10. Nolan Miller & Amit Pazgal, 2002. "Relative performance as a strategic commitment mechanism," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 23(2), pages 51-68.
    11. James A. Brander, 1995. "Strategic Trade Policy," NBER Working Papers 5020, National Bureau of Economic Research, Inc.
    12. Miller, Nolan H & Pazgal, Amit I, 2001. "The Equivalence of Price and Quantity Competition with Delegation," RAND Journal of Economics, The RAND Corporation, vol. 32(2), pages 284-301, Summer.
    13. Paul Krugman, 1986. "Industrial Organization and International Trade," NBER Working Papers 1957, National Bureau of Economic Research, Inc.
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