Limit Pricing, Climate Policies, and Imperfect Substitution

24 Pages Posted: 13 Dec 2016

See all articles by Gerard van der Meijden

Gerard van der Meijden

Vrije Universiteit Amsterdam, School of Business and Economics

Cees Withagen

Free University of Amsterdam; Tilburg University

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Date Written: November 08, 2016

Abstract

The effects of climate policies are often studied under the assumption of perfectly competitive markets for fossil fuels. In this paper, we allow for monopolistic fossil fuel supply. We show that, if fossil and renewable energy sources are perfect substitutes, a phase will exist during which the monopolist chooses a limit pricing strategy. If limit pricing occurs from the beginning, a renewables subsidy increases initial extraction, whereas a carbon tax leaves initial extraction unaffected. However, if initially fossil fuels are cheaper than renewables, a renewables subsidy and a carbon tax lower initial extraction, contrary to the case of perfect competition. Both policy instruments lower cumulative extraction. If fossil fuels and renewables are imperfect but good substitutes, the monopolist will exhibit ‘limit pricing resembling’ behavior, by keeping the effective price of fossil close to that of renewables for considerable time. The empirical question whether energy demand is elastic or inelastic has less drastic implications for the fossil price and extraction paths than under perfect substitutability.

Keywords: limit pricing, non-renewable resource, monopoly, climate policies

JEL Classification: Q310, Q420, Q540, Q580

Suggested Citation

van der Meijden, Gerard and Withagen, Cees A. M., Limit Pricing, Climate Policies, and Imperfect Substitution (November 08, 2016). CESifo Working Paper Series No. 6163. Available at SSRN: https://ssrn.com/abstract=2884568

Gerard Van der Meijden (Contact Author)

Vrije Universiteit Amsterdam, School of Business and Economics ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Cees A. M. Withagen

Free University of Amsterdam ( email )

Tinbergen Institute De Boelelaan 1105
1081 HV Amsterdam
Netherlands

Tilburg University ( email )

Postbus 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

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