Sell green and buy green: A signaling theory of green products

Abstract

In this paper, we reconsider the information problem of consumers who are concerned about the environment that was first identified by Mahenc, 2007, Mahenc, 2008. We obtain the result that Intuitive Criterion selects the unique equilibrium in which a seller producing eco-friendly products separates itself from the seller producing eco-unfriendly products by distorting its price from its first-best price upwards to the least costly degree. That is, a high price signals environmental friendliness. This is contrasted with the result of Mahenc (2007) who obtains the pooling equilibrium as the unique outcome (if the product is very likely to be eco-friendly) by using the concept of the undefeated equilibrium. We also examine the effect of the subsidy policy to promote consumptions of environmentally-friendly products by using Intuitive Criterion. Interestingly, a selective subsidy scheme can separate the high type from the low type but cannot provide the seller a strong enough incentive to invest in the environmental-friendly technology. We also show that if the motive of the monopolist, whether it is solely profit-maximizing or involves concerns for the environment, is its private information, a high price can signal the monopolist's environmental concerns and its voluntary choice of the eco-friendly technology.