Market power of firms and exchange-rate fluctuations

This paper explores the potential of firms to restrict industry outputs (market power) in oligopolistically organized markets where domestic firms compete with foreign ones. Within a stochastic price-setting supergame framework, market power is shown to be lower in general with flexible exchange rates for the following reasons. (i) The conditions that the fully collusive outcome—oligopolists maximizing joint profits — is sustainable in equilibrium become stronger if the exchange rate fluctuates, provided that fluctuations are sufficiently small. (ii) Even if full collusion can be sustained, industry outputs will be higher on the average with flexible than with fixed exchange rates.