Signaling environmental quality to green consumers and the incentive to invest in cleaner technology: Effect of environmental regulation
I consider an imperfectly competitive industry where firms signal the environmental attribute of their production technology through prices to environmentally conscious consumers that are not informed about the environmental damage caused by firms but are willing to pay more for "cleaner" products. I analyze the effect of changes in the level of environmental regulation on signaling behavior of firms and their incentive to develop cleaner technology. While cleaner firm types charge higher prices when regulation is weak, higher price does not signal better environmental performance when regulation is sufficiently stringent. With weak regulation, a monopolist has absolutely no incentive to invest in the development of a potentially less damaging technology even though consumers are willing to pay more for the product. This incentive is positive when regulation is strong enough. In a more competitive market structure (duopoly with price competition), firms may have strategic incentive to invest even when regulation is weak.
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