DP2771 Rivalry in Uncertain Export Markets: Commitment versus Flexibility

Author(s): Gerda Dewit, Dermot Leahy
Publication Date: April 2001
Keyword(s): Demand Uncertainty, Flexibility, Strategic Commitment, Trade Policy
JEL(s): D80, F12, F13
Programme Areas: International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2771

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.