Selection of cost-effective investment and output subsidies for eco-friendly products

Abstract

Investment subsidies and output subsides are two common subsidy schemes used to promote the diffusion of eco-friendly products (EFPs). We adopted an analytical model to study which type of subsidies should be employed in promoting EFP diffusion in a competitive market of traditional products. Considering that there is a pre-investment in producing EFPs and EFP production technology is immature, we assume that a firm that wants to produce EFPs needs to bear both switching costs and higher manufacturing costs. When encouraging firms to produce EFPs, the results show that output subsidies are less costly when the switching costs are in the middle range. Meanwhile, in the case of a large potential market and low EFP manufacturing costs, output subsidies are more likely to be employed in attracting firms to produce EFPs. When encouraging all firms to produce EFPs, output subsidies are less costly, as they face a low switching cost. In the case of a small potential market, however, investment subsidies are more likely to be implemented. Finally, we tested the robustness of these findings in a market composed of more than two firms. We explored the subsidies in a circumstance where only one firm produced EFPs and found that investment subsidies were more likely to be implemented under these circumstances.