Regulating Cournot Oligopoly with Environmental Externalities

Abstract

We construct a model to analyze an oligopoly with two types of technology that produce an undifferentiated product: a cleaner but more expensive technology and a dirtier but less expensive technology. We construct a two-stage model in which firms choose their technology in the first stage and their profit maximizing quantities in the second stage. We then introduce stage zero, in which the government chooses its policy: a lump-sum fee, a specific tax, a subsidy, or a permit to label the product produced with the cleaner technology. We show that the government can achieve the highest social welfare with eco-labeling when most of the consumers are eco-conscious. Otherwise a subsidy or a tax achieves the highest social welfare depending on the degree of environmental damage.