Cournot-Bertrand competition: a revisit of strategic trade policy in the third-market model

Purpose - – The purpose of this paper is to discuss the optimal policy settings of the home government for any combination of strategic variables adopted by home and foreign firms under Brander and Spencer’s third-market model framework. Design/methodology/approach - – This paper follows all the assumptions of Brander and Spencer with only two modifications: firms produce differentiated products, and firms choose different strategic variables. A two-stage game is set and the subgame-perfect Nash equilibrium is deduced following backward induction. Findings - – The authors arrive at a general, simple rule to determine the optimal policy of the home government for any combination of strategic variables: regardless of the strategic variable of the domestic firm, the optimal policy of the home country is an export subsidy (tax) as long as the foreign firm’s strategic variable is output (price). The optimal subsidy or tax of the home country is shown to move the equilibrium to the Stackelberg equilibrium where the domestic firm behaves as the leader while the foreign firm behaves as a follower under free trade. With appropriate interpretations and a suitable caveat, the above results still hold in the case with multiple foreign firms which may choose different strategic variables. Originality/value - – This paper fills the gap in the literature, and provides some more general results not easily detected in the original model of Brander and Spencer or Eaton and Grossman.