Strategic Trade Policies In International Rivalry When Competition Mode Is Endogenous

We investigate government subsidy policy where a domestic and a foreign firm can choose either price or quantity in a third-country market. We demonstrate that even though firms can earn higher profits under Cournot competition than under Bertrand competition regardless of nature of goods, choosing Bertrand competition is the dominant strategy for firms. This leads firms to face prisoners' dilemma. However, trade liberalization brings about a change from Bertrand to Cournot and increases equilibrium profits if goods are substitutes. If goods are complements, Bertrand competition prevails in spite of the government non-intervention. Hence, a move toward free trade increases not only firms' profits, but also social welfare of both countries irrespective of the nature of goods.