Strategic Trade Policy under Isoelastic Demand and Asymmetric Production Costs

We demonstrate that whether a good of a rival firm is a strategic substitute or astrategic 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 determinant. We derive optimal trade policies, which are dependant upon the firms’ form of strategic action. In particular, the optimal policy recommendation for the home government is to give an export subsidy to its firm if a choice variable of the foreign firm is a strategic substitute and to levy an export tax if it is a strategic complement. Acknowledgement Preliminary version of this paper was presented at the 43rd Annual Meeting of the Western Regional Science Association held in Maui, Hawaii, February 25-28, 2004 and an workshop on international trade held in Niigata, Japan, May 21, 2004. The authors wish to thank particiants, Kenneth E. Corey and Jota Ishikawa for comments. Akio Matsumoto is grateful for financial supports from Chuo University (Joint Research Grant, 0382) and the Japan Ministry of Education, Culture, Sports, Science and Technology (Grand-in-Aid for Scientific Research (B), 15330037).