Effects of Customers' Environmental Awareness and Environmental Regulations on the Emission Intensity and Price of a Product

Abstract

ABSTRACT We study the effects of customers' environmental awareness (CEA) and environmental regulations on the emission intensity and price of a product with a price‐ and carbon emission‐sensitive demand. First, we consider a continuous setting where the production policy can be adjusted to reach any desired level of emission intensity while considering either a carbon tax or a carbon cap policy. Second, we consider a discrete framework where each production policy is defined by a given amount of emission intensity, a unit production cost, and a fixed investment cost. Under both settings, we study the joint effect of CEA and environmental regulations on a firm's optimal policy. We compare the customer‐driven model (when demand is sensitive to price and emissions but without a carbon tax) to the taxation‐only model (when a carbon tax applies but demand is only sensitive to price). Our main results indicate that CEA is an efficient driver for better environmental performance, acting as a substitute for a carbon tax but, unlike a carbon tax, leading to a lower price for the customers. In addition, we demonstrate that the nonmonotonous effect of a carbon tax on production policy selection, which is a known result in the literature, is no longer valid if one considers CEA. From a social welfare perspective, we show that simultaneously increasing the carbon tax and CEA generally leads to a reduction of social welfare. We perform robustness tests and show that most of our findings are valid under different assumptions regarding demand and cost functions.