Optimal timing and scale of green technology with demand preferences for greener production

We study firms' decisions regarding the timing of installing green technology in production and the optimal mix between brown and green technologies. These decisions are driven by uncertain demand, which depends on consumers' environmental sensitivity and regulatory targets. Capital allocation is also influenced by the costs of brown and green technologies, as well as their relative efficiency in production. High regulatory targets for a green energy mix in production, such as those set within EU countries, help accelerate investment in green technologies; however, this may result in a lower scale of green technology adoption. Factors such as higher volatility and growth in demand, lower efficiency of green technologies, or high existing capacity may delay investment in the green transition. We also explore the effect of an uncertain regime shift toward more environmentally sensitive consumers on capital investment decisions. Finally, we consider the social planner's maximization problem, which captures the social planner's trade-off between the production efficiency and consumer surplus gains from brown technologies and their environmental costs. We derive the social planner's optimal green capital targets and show that escalating regulatory penalties and consumers' environmental sensitivity are effective in improving welfare.