A two-stage game theoretic model is developed in which firms in two producer blocs (the United States and Western Europe) produce a homogeneous defense good and sell it to their own governments and to the rest of the world. The security levels of the two producer blocs depend on their purchase of the defense good relative to the amount purchased by the rest of the world. Countries choose their security levels, such that their welfare, which depends on their security level and on government expenditure on other goods and services, is maximized. Results show that net defense costs of the United States and Europe are lower when the number of defense firms is small and that a further increase in world prices will crowd out developing countries from the market for modern weapon systems and may force them to develop and use “cheap and dirty” weapons.
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