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Environmental Policy and Firm Behavior: Abatement Investment and Location Decisions Under Uncertainty and Irreversibility

  • Anastasios Xepapadeas

This paper explores abatement investment and location responses to environmental policy, which takes the form of emission taxes or tradeable emission permits and subsidies against the costs of abatement investment, under uncertainty and irreversibility. Uncertainty is associated with output price, environmental policy parameters, or technological parameters. Irreversibility is related to abatement expenses and movements to a new location. Uncertainty is modeled by Itô stochastic differential equations, and the problem is analyzed by using optimal stopping methodologies. Continuation intervals during which firms do not engage in abatement investment or relocate and intervals during which firms take the irreversible decision of undertaking abatement expenses or relocating are defined. Free boundaries are characterized for a variety of cases that include output price uncertainty expressed both in terms of continuous fluctuations of permit prices and unpredictable policy changes, and combined policy and technological uncertainty. An optimal environmental policy is defined as the combination of policy parameters that makes the free boundary corresponding to the profit maximization problem coincide with the free boundary corresponding to a social optimization problem.

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File URL: http://www.nber.org/papers/t0243.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0243.

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Date of creation: Aug 1999
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Handle: RePEc:nbr:nberte:0243
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  1. Carraro, C. & Soubeyran, A., 1998. "R&D Cooperation, Innovation Spillovers and Firm Location in a Model of Environmental Policy," G.R.E.Q.A.M. 98a43, Universite Aix-Marseille III.
  2. Hartl, R.F. & Kort, P.M., 1996. "Marketable permits in a stochastic dynamic model of the firm," Other publications TiSEM 1a6e45ee-b1f0-41d9-a6d6-c, Tilburg University, School of Economics and Management.
  3. Kort, P.M., 1992. "The effects of marketable pollution permits on the firm's optimal investment policies," Discussion Paper 1992-42, Tilburg University, Center for Economic Research.
  4. Markusen James R. & Morey Edward R. & Olewiler Nancy D., 1993. "Environmental Policy when Market Structure and Plant Locations Are Endogenous," Journal of Environmental Economics and Management, Elsevier, vol. 24(1), pages 69-86, January.
  5. Xepapadeas, Anastasios, 1997. "Economic development and environmental pollution: traps and growth," Structural Change and Economic Dynamics, Elsevier, vol. 8(3), pages 327-350, August.
  6. Anastasios Xepapadeas, . "Optimal Resource Development and Irreversibilities: Cooperation and Noncooperative solutions," Working Papers 9803, University of Crete, Department of Economics.
  7. Arrow, Kenneth J & Fisher, Anthony C, 1974. "Environmental Preservation, Uncertainty, and Irreversibility," The Quarterly Journal of Economics, MIT Press, vol. 88(2), pages 312-19, May.
  8. Markusen, James R. & Morey, Edward R. & Olewiler, Nancy, 1995. "Competition in regional environmental policies when plant locations are endogenous," Journal of Public Economics, Elsevier, vol. 56(1), pages 55-77, January.
  9. Xepapadeas, A. P., 1992. "Environmental policy, adjustment costs, and behavior of the firm," Journal of Environmental Economics and Management, Elsevier, vol. 23(3), pages 258-275, November.
  10. Rauscher, Michael, 1994. "Environmental Regulation and the Location of Polluting Industries," CEPR Discussion Papers 1032, C.E.P.R. Discussion Papers.
  11. Carraro, Carlo & Soubeyran, Antoine, 1995. "Environmental Feedbacks and Optimal Taxation in Oligopoly," CEPR Discussion Papers 1156, C.E.P.R. Discussion Papers.
  12. Motta, Massimo & Thisse, Jacques-Francois, 1994. "Does environmental dumping lead to delocation?," European Economic Review, Elsevier, vol. 38(3-4), pages 563-576, April.
  13. Michael Rauscher, 1995. "Environmental regulation and the location of polluting industries," International Tax and Public Finance, Springer, vol. 2(2), pages 229-244, August.
  14. Fisher, Anthony C. & Hanemann, W. Michael, 1987. "Quasi-option value: Some misconceptions dispelled," Journal of Environmental Economics and Management, Elsevier, vol. 14(2), pages 183-190, June.
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