Environmental Regulation Under Sequential Competition

Abstract

We examine a polluting industry, competing à la Stackelberg, where an emission fee is sequentially set on the leader and the follower. We evaluate the leader's output advantage, disentangling two effects: the first-mover and cost advantage. We show that environmental regulation decreases the leader's output advantage, which is positive when firms are asymmetric. We also measure the output inefficiency if the regulator incorrectly assumes the industry competes simultaneously, identifying in which settings this inefficiency is the largest. Our extensions allow for inflexible emission fees, asymmetric pollution intensities, several leaders and followers, product differentiation, and for the follower to hold a cost advantage.

Keywords: Sequential competition, Pollution, Cournot competition, Cost asymmetry, Output advantage, Environmental regulation, Emission fees.