Strategic

This sheet sets out the basic `Airbus vs Boeing' example of strategic trade policy. The 'stylized facts' of this story are that Boeing and Airbus are considering production of a new jet that will be sold in a third market. The investment costs are sufficiently high that if both firms enter the market they will not be able to cover their investment and will make a loss. However, the market would be profitable to one firm alone. The purpose of the game is to show that a subsidy to can in effect give the recipient a first-mover advantage. If the subsidy is common knowledge, entering the market becomes a strictly dominant strategy for the recipient, and the optimal strategy for the other firm is not to enter. The model can illustrate the result, and also show its sensitivity to the assumptions. The payoff vectors can be adjusted to tell different stories using the spinners, as can the subsidy levels. The sheet works by using a simple check on the optimal strategy profiles, then using conditional formatting to highlight all the Nash equilibria. Solver is not required.

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Model Layout Guide

Exercises

Strategic Subsidies

Consider a European subsidy to Airbus that is large enough to make it produce. How does the Nash equilibrium change? You should find that Boeing will choose not to enter the market, since it knows that production by Airbus is becomes a strictly dominant strategy.The subsidy has given Airbus the equivalent of a first-mover advantage.

Retaliation

What if the government of USA was to respond the the European subsidy with a subsidy of its own? Would that level the playing field and return us to the initial equilibrium? Why or why not?

Changes in Efficiency

Change the payoffs slightly such that production for Boeing is a strictly dominant strategy (i.e., make the upper right payoff in the first strategy profile positive). This is equivalent to saying Boeing is slightly more efficient than Airbus, and can make a slight profit even if it has to share the market. How effective is the European subsidy now?

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