Emission Reduction by Voluntary Agreements: Oligopoly Market with Green Consumers

This paper evaluates the performance of voluntary agreements (VAs), relative to a tax or subsidy policy, as a way to reduce environmental pollution in an oligopoly context. The model is one of vertical product differentiation and heterogeneous consumers’ preferences over two goods: a standard polluting variety, and an environmentally friendly version that can be produced by the costlier process of a new technology. We find that a VA can improve welfare despite suffering from free-riding behavior. It can be preferable to a tax policy because it does not exacerbate the underproduction that arises under imperfect competition, and it can be more effective than a subsidy policy because it promotes firms’ adoption of green technology without affecting their marginal production decisions. The VA’s advantage in welfare terms wears off as the market becomes competitive. The effectiveness of all policies considered is weakened when ex ante credibility of policy levels is required, with the VA being affected the most. With a credible threat requirement, the VA is dominated by a subsidy policy for more concentrated oligopoly structures, and by the tax policy under more competitive conditions.