A model to analyze the environmental policy of resource reallocation and pollution control based on firms' heterogeneity

This paper presents an environmental policy model with heterogeneous firms to analyze the problem of “development–pollution”. The model shows how the policy corresponding to firms' productivity affects total output, resource consumption and pollution emission. We find that with the implementation of simple pollution tax, the lowest productive firms will exit from the market, at the same time total resource consumption and pollution emission will decrease at the loss of total output. The loss in total output leads some economies, especially the developing countries to fall into a development dilemma. However, if government subsidizes the more productive firms by reallocating tax revenue, total output will increase back to “ex-tax” situation. And more importantly, resource consumption and pollution emission in production could be below “ex-tax” situation. Our main finding are: (1) environmental policy reduces resource consumption and pollution emission; (2) total output could be maintained at a certain level if environmental policy is implemented appropriately.