Suppose Country 1 and Country 2 each have a firm that exports to countries other than Country 1 or Country 2. In the absence of government intervention, these firms behave as Cournot duopoly. The inverse demand curve in the other countries is P = 36 – q1 – q2. Assume that the firms produce at zero marginal cost.
A) Find out the Cournot equilibrium and calculate each firm’s profit.
B) Suppose that the government in Country 1 can intervene to help its firm without fear that the other government will retaliate. Government 1 gives a subsidy of s = 9 per unit to Firm 1. Find out the Cournot equilibrium and calculate each firm’s profit. Does the subsidy policy increase Country 1’s welfare? (Hint: Country 1’s welfare can be measured by Firm 1’s profit minus Government 1’s subsidy expenditure.)
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