No. 148 - Exchange Rate and Pricing Strategies in a Model of International Duopoly

by Paola Caselli
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The paper examines the effects of exogenous exchange rate movements in a model of international duopoly with differentiated products where prices are the choice variables. Alternative schemes of strategic interaction between firms are considered. If each duopolist makes "consistent" conjectures about the way the rival reacts to its price changes, the effects of a nominal depreciation of its currency on domestic and foreign prices and the real exchange rate may differ substantially from those found in the case of Cournot competition. Numerical simulations suggest that the differences between the Cournot and the consistent conjectures equilibrium (C.C.E.) depend crucially on the degree of substitution between foreign and domestic goods. In particular, if goods are close substitutes and wages are not affected by exchange rate variations, the C.C.E. implies a negligible effect on the real exchange rate, while the Cournot equilibrium predicts a significant real depreciation.