Environmental Policy in Vertical Markets with Downstream Pollution: Taxes Versus Standards

Yang-Ming Chang and Sellak Manaf ()
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Sellak Manaf: School of Business, Washburn University, Rm 310M Henderson Learning Center, 1700 SW College Ave., Topeka, KS 66621, USA

The B.E. Journal of Economic Analysis & Policy, 2023, vol. 23, issue 4, 897-923

Abstract: This paper examines the performance of two environmental regulation policies – emission taxes and absolute standards – in a vertical market where an upstream foreign monopolist sells a specific input to two downstream multiproduct firms that generate pollution in the domestic country. Specifically, we use a three-stage game to analyze and compare the two policies for regulating downstream pollution. In the first stage, the domestic government determines an optimal tariff and sets one of the two instruments (taxes or standards) by maximizing social welfare, in stage two, the upstream foreign monopoly sets its input price, and finally, the downstream domestic firms independently make their output and abatement decisions for profit maximization. We find that total emissions are lower under the absolute standard. Nevertheless, the tax dominates the standard in terms of domestic welfare, consumer surplus, and downstream multiproduct firms’ profits. Thus, the tax equilibrium leads to a win-win-win situation compared to the standard equilibrium. These results show the non-equivalence of emission taxes and absolute standards in regulating downstream pollution. The analyses suggest that a pollution tax is an economically and politically feasible policy.

Keywords: absolute standards; downstream pollution; emission taxes; vertical markets; welfare (search for similar items in EconPapers)
JEL-codes: L11 L22 Q58 (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (3)

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DOI: 10.1515/bejeap-2022-0255

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