A Dynamic Game of Strategic Carbon Taxation and Energy Pricing with Green Technology Innovation

Abstract This paper uses a dynamic game to investigate the strategic interactions between carbon taxation by a coalition of resource consumers and (wellhead) energy pricing by a producers’ cartel under the possibility of innovation in a cheap carbon-free technology. The timing of innovation is uncertain, but can be affected by the amount spent on R &D. The results show that the expectation of possible innovation decreases both the initial carbon tax and producer price, resulting in higher initial resource extraction and carbon emissions. Though this ’green paradox’ effect triggered by possible innovation also will appear in the cooperative case (without strategic interactions), the presence of strategic interactions between resource producers and consumers can somewhat restrain such an effect. For both the resource consumers and a global planner, the optimal R &D to stimulate innovation is an increasing function of the initial CO2 concentration. However, the resource consumers can over-invest in R &D relative to the investment level that a global planner would choose.