Environmental Policy in a Vertically Differentiated Product Market

Using a discrete-continuous model that deals with both consumers' choice and usage of an environmentally differentiated product in a utility-consistent framework, this paper investigates welfare impacts of emission taxes, subsidies and ad valorem taxes/subsidies on a green market where consumers emit a pollutant through their usage of the products offered by duopolists. An emission tax is always welfare dominant over a subsidy on consumers' purchase of the clean product because the emission tax contributes to a reduction in environmental damage by inducing firms to improve environmental qualities of the products and by constraining consumers' usage of the products. An ad valorem subsidy is always dominated by both an emission tax and a subsidy in terms of social welfare.