Horizontal product differentiation and policy adjustment in the presence of abatement subsidies and emission taxes

Abstract

There are important examples of countries which have implemented policies to promote pollution abatement activities in sectors characterised by some degree of product differentiation. This paper examines the role of product differentiation on optimal policy and industry emissions in a Cournot oligopoly model in the presence of abatement technology, abatement subsidies and emission taxes. The analysis indicates that as products become more differentiated the government can afford a tax increase due to the presence of subsidies and abatement technology. Additionally, highly differentiated industries may experience a rapid increase in emissions and so policies such as research and development (R&D) may be needed to tackle higher emissions. The government adjusts optimal policy as industries become more or less pollution-intensive, and the extent of the adjustment varies across industries characterised by different degrees of product differentiation. The analysis is potentially relevant to industries where firms are taking steps to differentiate their products in order to capture particular market niches, and lower production and abatement costs.