The Costs of Environmental Regulation in a Concentrated Industry

Abstract

The typical cost analysis of an environmental regulation consists of an engineering estimate of the compliance costs. In industries where fixed costs are an important determinant of market structure this static analysis ignores the dynamic eects of the regulation on entry, investment, and market power. I evaluate the welfare costs of the 1990 Amendments to the Clean Air Act on the US Portland cement industry, accounting for these eects through a dynamic model of oligopoly in the tradition of Ericson and Pakes (1995). Using a recently developed two-step estimator, I recover the entire cost structure of the industry, including the distribution of sunk entry costs and adjustment costs of investment. I find that the Amendments have significantly increased the sunk cost of entry. I solve for the Markov perfect Nash equilibrium (MPNE) of the model and simulate the welfare eects of the Amendments. A static analysis misses the welfare penalty on consumers, and may even obtain the wrong sign of the welfare eects on incumbent firms.