Environmental liability and product differentiation: Strict liability versus negligence revisited

Abstract

This paper studies the role of environmental liability in shaping firms’ product differentiation choices, both horizontally (product design) and vertically (safety), and the ensuing welfare implications. We use a spatial Cournot duopoly where firms’ activity may entail accidental environmental harm. We show that for low levels of harm, both strict liability and negligence lead to a fully symmetric equilibrium with no differentiation: strict liability provides less output and more safety (thus, lower expected environmental harm) than negligence. Nevertheless, negligence affords higher welfare. For higher environmental harm, only strict liability yields an equilibrium where firms differentiate both horizontally and vertically: each firm becomes dominant (dominated) on a subset of local markets, where it delivers more (less) output and much more (less) safety than in the no-differentiation equilibrium under negligence. In this case, strict liability provides higher welfare.