egy taking into account the exchange rate and then export abroad. Under price
competition this corresponds to the case of producer currency pricing. Such a
case is typical of medium and small firms which are active at a national level,
often producing typical domestic products and exporting some of them abroad,
but also of larger firms which are not directly active in the foreign market under
consideration but sell their goods to distributors of this market.19 Once again,
we will separate the discussion between the cases of quantity competition and
price competition. The bottom line will be that competitive devaluations are
always desirable to provide a strategic advantage to domestic firms when foreign
markets are competitive.
Potentially, one could extend this framework to derive an optimal compet-
itive devaluation comparing its benefits on the export side with its costs on
the import side. However, one must always keep in mind that this analysis is
relevant in the short run: as well known, in the long run, markets equilibrate in
such a way that nominal variables, as the exchange rate, are irrelevant.
3.1 Competitive devaluations with Cournot competition
Imagine a quantity competition in the foreign market. Foreign demand for
good i is as usual pi = p xi, Pj6=i h(xj) where xj is production for firm j, but
revenues in domestic currency are Eixipi where Ei is the price of the foreign
currency in terms of currency of country i, that is the exchange rate of this
country. For expository purposes, imagine an initial situation where, without
loss of generality, all the exchange rates (with the foreign country where firms
compete) are unitary. If the domestic country can adopt a competitive devalu-
ation and rise the exchange rate to the level E , the profit of the domestic firm
becomes:
ΠH = Ezp (z, βH) - c(z) (17)
which can be rewritten in our framework as ΠH (z, βH,s)wheres = E - 1,
implying Π1H3 = p + zp1 = c0 (z)/E > 0. Hence Prop. 1 and 3 apply and
19 The alternative situation, which is not relevant for our purposes, emerges when interna-
tional firms produce and compete abroad with independent production units. This is typical
of multinational firms which are directly active in other countries where they sell their prod-
ucts. Under price competition, this case of local currency pricing with market power implies
no pass-through of the nominal exchange rate on prices. In this situation, a devaluation is not
going to affect the equilibrium in the foreign market. All firms would choose the same prices in
foreign currency after a devaluation, but the profits of the domestic firm would be artificially
increased in the domestic currency. The same would happen under quantity competition,
since production decisions abroad would be independent from the exchange rate again, but
profits in domestic currency would be inflated by a devaluation. It is clear that such a gain
in profits should be compared with the losses for the society in terms of higher prices of the
imports. However, this is not our focus; what matters for our purposes is that in such a
context there is not a strategic incentive to implement a competitive devaluation. This policy
does not give a real strategic advantage to the domestic firm in the foreign market but just
artificially increases its profits.
16