Conjectural Variations, Market Power, and Optimal Trade Policy in a Vertically Related Industry

The paper introduces the conjectural variations and bargaining approaches into a vertical model wherein a foreign upstream firm supplies one input to two downstream firms that produce differentiated products for the export market. Various downstream firms' competition modes and upstream's pricing schemes emerge as special cases of this formulation. The authors show that the optimal export policy of a downstream country depends crucially on the downstream firms' conjectures of rivals' responses, the upstream firm's pricing schemes, their relative bargaining powers, and the degree of product differentiation. If the upstream's pricing or bargaining power is strong (weak) and if the downstream's degree of competition is high (low), a tax (subsidy) is optimal owing to a strong (weak) vertical profit-shifting effect and a weak (strong) horizontal effect. Copyright Blackwell Publishing Ltd 2004.