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Limit Pricing, Climate Policies, and Imperfect Substitution

Listed author(s):
  • Gerard C. van der Meijden
  • Cees A. Withagen
Registered author(s):

    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.

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    File URL: http://www.cesifo-group.de/DocDL/cesifo1_wp6163.pdf
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    Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 6163.

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    Date of creation: 2016
    Handle: RePEc:ces:ceswps:_6163
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    1. 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.
    2. 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.
    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.).
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