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Investment in Cleaner Technology and Signaling Distortions in a Market with Green Consumers

  • Aditi Sengupta

I analyze the pricing and investment behavior of a firm that signals the environmental attribute of its production technology through its price to uninformed environmentally conscious consumers. I then analyze the effect of change in environmental regulation on the signaling outcome and the firm's ex ante incentive to invest in cleaner technology. When regulation is weak, a firm signals cleaner technology through higher price; in this case, the firm earns lower profit when it has cleaner technology and thus, has no incentive to invest in cleaner technology. The price charged by the clean firm declines sharply beyond a critical level of regulation. When regulation is sufficiently stringent, the firm with cleaner technology charges lower price but earns higher signaling profit, and ex ante the firm has positive incentive to invest in cleaner technology. With weak regulation, the incentive of the firm to directly disclose its environmental performance rather than signal it through price (signaling distortion of profit) is increasing in the level of regulation, but the opposite holds when regulation is sufficiently stringent.

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File URL: http://cla.auburn.edu/econwp/Archives/2011/2011-10.pdf
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Paper provided by Department of Economics, Auburn University in its series Auburn Economics Working Paper Series with number auwp2011-10.

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Date of creation: Aug 2011
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Handle: RePEc:abn:wpaper:auwp2011-10
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