The indirect effects of sector-specific emission policy: who wins and who loses?
(A2026-132990)

AUTHORS

Sumitro Banerjee, Grenoble Ecole de Management; David Soberman, Rotman School of Management, University of Toronto

ABSTRACT

This paper examines the indirect effects of sector-specific emissions policies in a vertically differentiated duopoly where each firm generates a constant per-unit carbon emission and a significant share of demand originates from environmentally conscious consumers. Firms can undertake a one-time fixed-cost investment that lowers their emissions intensity, and we study their strategic responses under two regulatory mechanisms---carbon taxation (CT) and cap-and-trade (CAT). We characterize equilibrium prices, demands, emissions decisions, and carbon footprints (CFPs). We find that under non-trivial technological costs of emissions reduction, the low-quality firm ultimately serves a smaller market share than the high-quality firm but nonetheless achieves a lower total CFP---even though the high-quality firm reduces its emissions by a larger absolute amount. Per-unit emissions reduction is greater for the low-quality firm whenever the regulator's target emissions lie below a threshold. Under CAT, the low-quality firm ends up below its allocated emissions cap whereas the high-quality firm exceeds its cap and incurs penalties. Although CT and CAT yield identical equilibrium emissions for each firm when designed optimally, firm profits are higher under CAT. By contrast, total surplus is higher under CT when the industry emissions target is sufficiently stringent.