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Limit pricing, climate policies, and imperfect substitution

Gerard van der Meijden and Cees Withagen

Resource and Energy Economics, 2019, vol. 58, issue C

Abstract: The effects of climate policies are often studied under perfect competition and constant marginal extraction costs. In this paper, we allow for monopolistic fossil fuel supply and more general cost functions, which, in the presence of perfectly substitutable renewables, gives rise to limit-pricing behavior. Four phases of supply may exist in equilibrium: sole supply of fossil fuels below the limit price, sole supply of fossil fuels at the limit price, simultaneous supply of fossil fuels and renewables at the limit price, and sole supply of renewables at the limit price. The consequences of climate policies for initial extraction depend on the initial phase: in case of sole supply of fossil fuels at the limit price, a renewables subsidy increases initial extraction, whereas a carbon tax leaves initial extraction unaffected. With simultaneous supply at the limit price or with sole supply of fossil fuels below the limit price, a renewables subsidy and a carbon tax lower initial extraction. Both policy instruments decrease cumulative extraction. If fossil fuels and renewables are imperfect but good substitutes, the monopolist will exhibit ‘limit-pricing resembling’ behavior, by keeping the effective price of fossil close to that of renewables for considerable time.

Keywords: Limit pricing; Non-renewable resource; Monopoly; Climate policies (search for similar items in EconPapers)
JEL-codes: Q31 Q42 Q54 Q58 (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:eee:resene:v:58:y:2019:i:c:s0928765518301982

DOI: 10.1016/j.reseneeco.2019.101118

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