Much of the analysis of the economic impact of environmental policies (such as emission taxes) takes place under the assumption that markets are perfectly competitive. When markets are imperfectly competitive the impact of environmental policy is more problematic, both in terms of positive predictions and welfare analysis. In Discussion Paper No 1156, Research Fellow Carlo Carraro and Antoine Soubeyran extend the analysis of environmental policy in an imperfectly competitive industry in two directions. First, they allow for the possibility that reduction in emissions of pollution caused by the production of a good can affect the demand for the good itself. Second, they allow for firms to have different unit costs of production and so to have different market shares.

The first part of the paper focuses on the comparative static effects of the environmental tax. It is shown that the market share and profits of some firms can increase when the tax rate is raised if environmental feedbacks are sufficiently high and the industry is not very asymmetric. The relationship between industry concentration and emission taxation is also explored. In the second part of the paper, the authors face the problem of optimal taxation. They show that there may exist an optimal tax such that some firms increase their profits and/or their market share. Moreover, the optimal tax rate is inversely related to the industry asymmetry (the variance of firms' marginal costs), and positively related to the perceived environmental damage.

Environmental Feedbacks and Optimal Taxation in Oligopoly
Carlo Carraro and Antoine Soubeyran

Discussion Paper No. 1156, April 1995 (IO)