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Limit Pricing, Climate Policies, and Imperfect Substitution

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  • Gerard C. van der Meijden
  • Cees A. Withagen

Abstract

The effects of climate policies are often studied under the assumption of perfectly competitive markets for fossil fuels. In this paper, we allow for monopolistic fossil fuel supply. We show that, if fossil and renewable energy sources are perfect substitutes, a phase will exist during which the monopolist chooses a limit pricing strategy. If limit pricing occurs from the beginning, a renewables subsidy increases initial extraction, whereas a carbon tax leaves initial extraction unaffected. However, if initially fossil fuels are cheaper than renewables, a renewables subsidy and a carbon tax lower initial extraction, contrary to the case of perfect competition. Both policy instruments lower cumulative extraction. If fossil fuels and renewables are imperfect but good substitutes, the monopolist will exhibit ‘limit pricing resembling’ behavior, by keeping the effective price of fossil close to that of renewables for considerable time. The empirical question whether energy demand is elastic or inelastic has less drastic implications for the fossil price and extraction paths than under perfect substitutability.

Suggested Citation

  • Gerard C. van der Meijden & Cees A. Withagen, 2016. "Limit Pricing, Climate Policies, and Imperfect Substitution," CESifo Working Paper Series 6163, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_6163
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    References listed on IDEAS

    as
    1. Gilbert, Richard J. & Goldman, Steven M., 1978. "Potential competition and the monopoly price of an exhaustible resource," Journal of Economic Theory, Elsevier, vol. 17(2), pages 319-331, April.
    2. Andrade de Sá, Saraly & Daubanes, Julien, 2016. "Limit pricing and the (in)effectiveness of the carbon tax," Journal of Public Economics, Elsevier, vol. 139(C), pages 28-39.
    3. Niko Jaakkola, 2013. "Putting OPEC Out of Business," OxCarre Working Papers 099, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    4. Stephen W. Salant, 1977. "Staving off the backstop: dynamic limit-pricing with a kinked demand curve," International Finance Discussion Papers 110, Board of Governors of the Federal Reserve System (U.S.).
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    limit pricing; non-renewable resource; monopoly; climate policies;

    JEL classification:

    • Q31 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Demand and Supply; Prices
    • Q42 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Alternative Energy Sources
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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