Environmental taxation in the Bertrand differentiated duopoly: New insights

Abstract

We derive an optimal emission tax under imperfect competition among polluters, while taking into account the significance of the spatial dimension for non-uniformly mixed pollutants. This setup reflects a large number of pollution scenarios across developed and developing countries. We build a partial equilibrium model that is based on Hotelling’s location model, and that is further generalized to include the polluters’ abatement levels. First, the firms’ locations are considered to be exogenous, but later we relax this assumption. Our results shed light on a trade-off between the environmental externality and the distortions resulting from the Bertrand competition. This trade-off is modulated by the locations of the two producers as well as preferences for a clean environment. Our results also indicate that, in the presence of more than one market failure, the principle of maximal differentiation is not always guaranteed. We further stress that designing a spatial emission tax is not too demanding in terms of regulator information. Lastly, we reveal that when environmental awareness is well-promoted, the green preference would be a cheaper anti-pollution instrument than emission taxes.