On Environmental Subsidy/Tax Policy with Heterogeneous Consumers: An Application of an Environmentally Differentiated Duopoly Model

We apply a model of an environmentally differentiated duopoly to the analysis of environmental policy in the form of a subsidy/tax on consumers based on emission levels of products. More specifically, we consider environmental and welfare effects of subsidizing consumers who purchase environmental-friendly goods such as hybrid vehicles. Focusing on types of market coverage by heterogeneous consumers, we examine the issue in the cases of a Bertrand and a Cournot duopoly. In the case of full market coverage with a Bertrand duopoly, an environmental subsidy improves the environment and is socially optimal. However, in the case of partial market coverage, irrespective of mode of competition, the optimal policy depends on the magnitude of the marginal social valuation of environmental damage. That is, if the marginal social valuation of environmental damage is sufficiently large (small), an environmental tax (subsidy) is optimal. Furthermore, in the Bertrand duopoly case, the effect of subsidy on the environment is ambiguous, whereas in the Cournot duopoly case, the subsidy degrades the environment.