International Trade Policy towards Monopoly and Oligopoly*

This paper highlights the importance of product differentiation and endogenous R&D in determining the optimal R&D policy, in a model where investment in cost‐reducing R&D is committed before firms compete in a differentiated‐goods third‐country export market. R&D is always taxed in oligopolies for high degrees of product differentiation. For lower degrees of product differentiation the duopoly is subsidized or the government remains inactive. In contrast, the monopoly is always subsidized. The government with a duopoly may be active or inactive depending on the degree of product differentiation. Thus, we may observe a reversal in the sign of the optimal R&D policy if the degree of product differentiation changes or, alternatively, if there is a change in the number of firms. Similar qualitative results hold if trade policy uses output subsidies, instead of R&D promotion.