Non-Homothetic Preferences

The variety expansion model with constant substitution elasticity in Chap. 4 is extended to the Direct Explicitly Additivity (DEA) model, in which the direct utility function is explicitly added. This non-homothetic preference creates competition between goods sector firms and alters the growth effects of environmental policy. When the mark-up rate rises with goods production, environmental tax leads to pollution reduction and economic growth through imperfect pass-through effects. However, when the mark-up rate falls with goods production, the environmental tax increases pollution emissions and decreases the economic growth rate through perfect pass-through effects. To pass on the environmental tax to the price, the production volume of the goods company temporarily decreases, however, the mark-up rate increases. Due to this increase, the goods company increases production and pollution emissions. In addition, due to the stagnation of variety development accompanying the labour transfer from the R&D to the goods sector, the economic growth rate decreases. Therefore, the growth promotion effect of environmental policy can change depending on the demand composition.