Rivalry in Uncertain Export Markets: Commitment versus Flexibility

Abstract:     
This Paper examines optimal trade policy in a two-period oligopoly model, with a home and a foreign firm choosing capital and output. Demand uncertainty, resolved in period two, gives rise to a trade-off between strategic commitment and flexibility in the firms? investment decisions. When the government can commit to an export subsidy, it may choose to over- or under-subsidize to deter private-sector capital commitment. When the government chooses its trade policy flexibly, the relative value of commitment to the unsubsidized foreign firm is greater than to the subsidized home firm. Finally, a flexible subsidy regime is compared to free trade.

Number of Pages in PDF File: 38

Keywords: Demand uncertainty, flexibility, strategic commitment, trade policy

JEL Classification: D80, F12, F13

working papers series