Strictness of Environmental Policy and Investment in Abatement

In this paper we model an oligopoly where .rms invest in abatement technologies and emissions are taxed by the government. We show that a stricter environmental policy does not necessarily lead to an increase in .rms.R&D investment into cleaner production methods. In fact, the emission-to-output ratio may be a U-shaped function of the environmental damage parameter. This result holds both when the government can commit and in the social optimum. When the government cannot commit, this relationship is ambiguous except in markets with few .rms. Our results further suggest that if the emission-to-output ratio is decreasing throughout, output is a U-shaped function of the environmental damage.