Demand elasticities, asymmetry and strategic trade policy

This paper shows that demand elasticities and cost asymmetry are important determinants of strategic trade policy. In the symmetric case, the direction of intervention is critically dependent upon the elasticity of demand. Under unit elastic demand, free trade is optimal under symmetry, and a subsidy (tax) is optimal if the exporting firm has lower (higher) marginal cost than its competitor. If both the exporting governments intervene, then the conventional result that the lower cost firm gets the higher subsidy is reversed for inelastic demand. However, such an equilibrium is unstable in policy space.