ECON6023 · International Trade
Trade Policy II: Export Subsidies and Strategic Trade
Week 11 covers export policy — export subsidies and export tariffs/quotas — and the key contrast between an export subsidy and a production subsidy (which carries a smaller deadweight loss because it does not distort consumption). It then turns to strategic trade policy for high-technology industries, analysed with a game-theoretic payoff matrix, a topic that recurs as an applied exam question.
What this chapter covers
- 01Export subsidy, small country: home price rises to P_W + s; net welfare = −(b + d), like a small-country tariff
- 02Export subsidy, large country: world price falls (terms-of-trade LOSS e); net welfare = −(b + d + e), never a gain
- 03Production subsidy: raises the price to producers but not to consumers; deadweight loss = area c only (the targeting principle)
- 04Export tariff/quota: small country net welfare = −(b + d); large country can gain via terms of trade (beggar-thy-neighbour)
- 05Strategic trade policy (Brander-Spencer): duopoly, positive externalities/spillovers, first-mover advantage
- 06Game theory: payoff matrix, best responses, Nash equilibrium; multiple equilibria with large fixed costs
- 07A subsidy can shift the equilibrium so the domestic firm produces and the rival exits — a possible national gain
- 08Caveat: if both firms still produce, the subsidy is a net national loss (subsidy cost exceeds the profit gain)
Strategic trade policy: an export subsidy in a duopoly
- +1Nash equilibria without policy. There are two: (Skyjet produces, Aeronova stays out) and (Skyjet stays out, Aeronova produces). Whoever produces alone earns 100; the market only supports one firm profitably, so which equilibrium occurs may hinge on a first-mover advantage.
- +1Subsidy makes producing dominant for Skyjet. Adding 25 to Skyjet's produce payoffs: if both produce it now earns −5 + 25 = 20 > 0; if it produces alone, 100 + 25 = 125. Whatever Aeronova does, Skyjet prefers to produce — producing is a dominant strategy.
- +1Aeronova's best response and the new equilibrium. Anticipating that Skyjet produces, Aeronova compares producing (−5) with staying out (0) and exits. The unique Nash equilibrium is now Skyjet produces alone, earning 100 + 25 = 125.
- +1National welfare and the caveat. Home's firm earns 125; net of the 25 subsidy, national welfare rises by 125 − 25 = 100 (versus 0 before). The caveat: if the subsidy fails to drive the rival out and both firms produce, it is a net national loss — the subsidy cost exceeds the profit gain — so strategic subsidies are not reliably in the national interest.
Key terms
- Export subsidy
- A payment per unit exported. It raises the home price to P_W + s; a small exporter's net welfare change is −(b + d), and a large exporter's is −(b + d + e) because the world price falls — an export subsidy can never raise a large exporter's welfare.
- Production subsidy
- A payment per unit produced. It raises the price to producers but leaves the consumer price at P_W, so consumption is undistorted and the deadweight loss is area c only — smaller than an export subsidy's loss.
- Targeting principle
- To achieve a goal, use the instrument that acts most directly on it. A production subsidy supports output with less distortion than an export subsidy, which also distorts consumption — the reason its deadweight loss is smaller.
- Export tariff
- A tax on exports. A small country's net welfare change is −(b + d); a large country raises the world price (terms-of-trade gain e) and can gain overall — a beggar-thy-neighbour policy, as with rare-earth export restrictions.
- Strategic trade policy (Brander-Spencer)
- Government intervention in an imperfectly competitive industry (a duopoly with large fixed costs) that shifts the Nash equilibrium in the domestic firm's favour, potentially raising national welfare if the rival exits.
- Nash equilibrium
- A profile where each firm plays its best response to the other's action. With large fixed costs a strategic-trade game can have two Nash equilibria (only one firm produces), and a subsidy can select the one favouring the home firm.
Trade Policy II: Export Subsidies and Strategic Trade FAQ
Why does a production subsidy cause a smaller loss than an export subsidy?
Because it distorts only one margin. A production subsidy raises the price producers receive but leaves the consumer price unchanged, so consumption is undistorted and the deadweight loss is just the production-side area c. An export subsidy raises the home price to P_W + s, distorting both production and consumption, so its loss is −(b + d) for a small country and worse for a large one. This is the targeting principle: hit the goal with the least distorting instrument.
Why can a large country never gain from an export subsidy but can gain from an import tariff?
An export subsidy pushes more goods onto the world market, lowering the world price — a terms-of-trade LOSS for the exporter, so its net welfare is −(b + d + e), always negative. A large-country import tariff does the opposite: it restricts imports and lowers the foreign price, a terms-of-trade GAIN that can outweigh the deadweight loss. The direction of the terms-of-trade effect is what flips the result.
Can AI help me with strategic trade and subsidy questions?
Yes. Sia can build the payoff matrix, find best responses and Nash equilibria, show how a subsidy makes producing dominant, and walk the export-vs-production-subsidy welfare comparison step by step. It explains the method and checks your reasoning; it does not do graded assessment, and USyd academic-integrity rules apply. Confirm exam coverage on Canvas.
When is a strategic subsidy actually in the national interest?
Only when it makes the foreign rival exit, so the domestic firm captures the whole market and its profit gain exceeds the subsidy cost. If the subsidy merely lets both firms produce, the subsidy is spent without displacing the rival and national welfare falls. That fragility is why the model warns strategic subsidies are unlikely to pay off when both firms remain in the same market.
Exam move
Learn the export-policy welfare results as a matched set: export subsidy small country −(b + d), large country −(b + d + e); production subsidy −c only (targeting principle); export tariff/quota small −(b + d), large e − (b + d) with a possible gain. For strategic trade, practise building a payoff matrix, finding best responses and Nash equilibria, and showing how a subsidy shifts the equilibrium — and always state the both-firms-produce caveat. Keep the running applications (agricultural subsidies, the Boeing/Airbus dispute) as examples. Confirm exam timing on Canvas.
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