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Environmental policy under product differentiation and asymmetric costs - Does Leapfrogging occur and is it worth it?

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  • Rothfels, Jacqueline

Abstract

This paper studies the influence of environmental policies on environmental quality, domestic firms, and welfare. Point of departure is Porter's hypothesis that unilateral environmental regulation may enhance the competitiveness of domestic firms. This hypothesis has recently received considerable support in theoretical analyses, especially if imperfectly competitive markets with strategic behavior on behalf of the agents are taken into account. Our work contributes to this literature by explicitely investigating the implications of asymmetric cost structures between a domestic and a foreign firm sector. We use a partial-equilibrium model of vertical product differentiation, where the consumption of a product causes environmental harm. Allowing for differentiated products, the domestic industry can either assume the market leader position or lag behind in terms of the environmental quality of the produced product. Assuming as a benchmark case that the domestic industry lags behind, we investigate the possibility of the government to induce leapfrogging of the domestic firm, i.e. a higher quality produced by the domestic firm after regulation than that of the competitor prior to regulation. It is shown that in the case of a cost advantage for the domestic firm in the production process the imposition of a binding minimum quality standard can serve as a tool to induce leapfrogging. In case of a cost disadvantage the same result can be achieved through an adequate subsidization of quality dependend production costs. Thus, careful regulation enables the domestic firm in both scenarios to better its competitive position against foreign competitors and to earn larger profits. Additionally, environmental quality and welfare can be enhanced.

Suggested Citation

  • Rothfels, Jacqueline, 2000. "Environmental policy under product differentiation and asymmetric costs - Does Leapfrogging occur and is it worth it?," IWH Discussion Papers 124, Halle Institute for Economic Research (IWH).
  • Handle: RePEc:zbw:iwhdps:iwh-124
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    File URL: https://www.econstor.eu/bitstream/10419/77029/1/124.pdf
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    References listed on IDEAS

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    1. Xepapadeas, Anastasios & de Zeeuw, Aart, 1999. "Environmental Policy and Competitiveness: The Porter Hypothesis and the Composition of Capital," Journal of Environmental Economics and Management, Elsevier, vol. 37(2), pages 165-182, March.
    2. Avner Shaked & John Sutton, 1982. "Relaxing Price Competition Through Product Differentiation," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 3-13.
    3. Simpson, R. David & Bradford, Robert III, 1996. "Taxing Variable Cost: Environmental Regulation as Industrial Policy," Journal of Environmental Economics and Management, Elsevier, vol. 30(3), pages 282-300, May.
    4. Rauscher, Michael, 1997. "International Trade, Factor Movements, and the Environment," OUP Catalogue, Oxford University Press, number 9780198290506.
    5. Klein, Martin & Rothfels, Jacqueline, 1999. "Can Environmental Regulation of X-Ineffecient Firms Create a -Double Dividend-?," IWH Discussion Papers 103, Halle Institute for Economic Research (IWH).
    6. Jaskold Gabszewicz, J. & Thisse, J. -F., 1979. "Price competition, quality and income disparities," Journal of Economic Theory, Elsevier, vol. 20(3), pages 340-359, June.
    7. Karen Palmer & Wallace E. Oates & Paul R. Portney, 1995. "Tightening Environmental Standards: The Benefit-Cost or the No-Cost Paradigm?," Journal of Economic Perspectives, American Economic Association, vol. 9(4), pages 119-132, Fall.
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    More about this item

    JEL classification:

    • Q2 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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