Identifying the Optimal Environmental Policy in Competitive Markets with Concerned Consumers

Abstract

Using vertical differentiation to represent heterogeneous producers and consumers within a competitive market, I examine the social welfare implications of emission permits, emission taxes, and voluntary emission certifications. My objective is to identify if conditions exist where government certification of green products yields a welfare improvement over alternative regulatory approaches, thereby illustrating that capturing consumer environmental preferences in a market yields a better outcome, in the presence of an externalities, than other regulatory approaches. Using a competitive market framework, my theoretical model allows for two distinct ramifications from using an environmental policy: raising production costs and forcing firms to exit from the market. My analysis shows that green-certification is a welfare-improving policy, and I provide conditions under which green-certification improves social welfare over traditional emission taxes or permits. However, these welfare gains are obtained through “green” consumer surplus as opposed to public benefitting emission reductions.