Rule-based profit taxation in dynamic Cournot oligopoly: Transmission, stability and welfare

Abstract

This study develops a dynamic Cournot model to examine whether profit taxation can stabilise oligopolistic markets hit by demand shocks. The tax rate is updated each period by a simple welfare rule, allowing fiscal policy to respond automatically to changing market conditions. The analysis connects the effectiveness with which taxes influence firms' decision-making (the transmission strength) to market stability. Simulations and chaos analysis show that when the tax signal is strong, firms adjust smoothly, volatility falls and competition is preserved. In contrast, when transmission is weak, feedback effects magnify shocks, increasing exit risk and market concentration. Moderate shocks are absorbed through temporary tax changes, while stronger demand shocks in the model mainly threaten the high-cost firm. Overall, transparent and predictable profit taxation serves as a practical stabiliser in concentrated industries, limiting volatility without ad hoc measures and providing a scalable framework for future fiscal design.