customs_union_and_common_market_theory addendum

customs_union_and_common_market_theory addendum - Addendum...

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Addendum to lecture 3 Presented in lecture 4
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“New” Trade Theory Main ideas : trade can be result of economies of scale economies of scale imperfect competition international trade larger market variety of products prices intra -industry trade dumping (international price discrimination) external economies of scale
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Strategy in a Duopoly Model Two firms, one industry, new aircraft decision. Produce or Not Produce. Payoff Table at right. Payoffs to each given strategy choice of other. Assume particular structure. Features: If both firms choose to produce new aircraft, both suffer losses. If either firm is sole producer, then they make substantial profits. Equilibrium: Advantage to firm that moves first. First-mover captures entire market, no incentive for other firm to enter. No unique equilibrium. Firm could guarantee market if had credible entry commitment. Airbus Boeing Produce No Prod’n Produce -5 -5 0 100 No Prod’n 100 0 0 0
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Effects of a Subsidy to Airbus Targeted Gov’t subsidy can provide a credible entry commitment. Assume EU guarantees Airbus a $25 mill. Subsidy to produce new aircraft. New Payoff Table at right. Payoffs to Airbus change. Features: Profitable for Airbus to enter regardless of Boeing strategy. Boeing knows Airbus will enter, so Boeing will not to avoid loss. Equilibrium with Subsidy Subsidy ensures Airbus produces new aircraft & Boeing does not enter. EU Subsidy acts as deterrent to U.S. firm, allows EU industry to capture industry. Airbus Boeing Produce No Prod’n Produce 20 -5 0 100 No Prod’n 125 0 0 0
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Strategic Trade Policy Targets Domestic gain from a targeted gov’t export subsidy depends on how gov’t intervention affects strategic interaction between domestic & foreign firms. Argument requires imperfect competition in targeted industry. Depends on form of strategic competition. Credible commitment to large expenditures on capital and R&D can play central role in strategic interaction. If this strategic game occurs early in product lifecycle, it will have major impacts on profitability in mature product phase. Avoid industries where Foreign Gov’t providing subsidies. Matching subsidies “levels the playing field” for domestic firms Industry as a whole likely to face lower prices, and profits. Why export subsidies rather than subsidy to domestic prod’n? Export targeting based on raising profits of domestic firms at expense of foreign rivals. Ignores consumer benefits/costs from policy.
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Preferred Industry Characteristics Substantial Barriers to Entry Additional returns expected to exceed cost of subsidy. Serious Foreign Competition or Potential Competition
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customs_union_and_common_market_theory addendum - Addendum...

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