Pricing and carbon reduction strategies for vertically differentiated firms under Cap-and-Trade regulation

Abstract

This paper develops a price and low-carbon competition model for two vertically differentiated firms, a high-quality manufacturer (HM) and a low-quality manufacturer (LM), with consumers who prefer low-carbon products. The implementation of the cap-and-trade regulation (CATR) by the government is essential for the carbon trading market where firms can choose to buy (resp., sell) carbon quota when the unit carbon emission reaches above (resp., below) the allocated quota. An investigation is conducted into how the pricing and carbon reduction rate (CRR) of manufacturers would be affected by the CATR and low-carbon preference of consumers. In the absence of CATR, price and CRR always show a positive correlation for a manufacturer. However, under the CATR, hiking price is not necessarily the best choice for the manufacturer when the CRR is increased. Furthermore, contrary to the conventional wisdom, we demonstrate that in order to motivate manufacturers to increase CRR, the government should increase the unit carbon quota rather than reduce it. Moreover, it is demonstrated in this paper that the enforcement of the CATR does not necessarily result in a higher CRR, a lower total carbon emission, or higher social welfare. The government should be mindful in designing the CATR and choosing the unit carbon quota to achieve the desired outcome.