Environmental Policy and Market Structure: A Case of Asymmetric Firms

This study seeks to analyze the impact of governmental regulations on the pollution level in a duopoly framework with endogenous market structure. We consider a dirty industry which involves two asymmetric firms, an MNC and a domestic firm, producing a homogenous product, where the MNC is so efficient that in the absence of a joint venture the MNC firm will act as a monopolist. We use a game theoretic framework to demonstrate that an increase in abatement cost, arising out of stricter government regulations, could trigger a regime-switch from monopoly to joint venture (or from joint venture to monopoly), and consequently may increase pollution. Turning to the welfare analysis, we find that the constrained first best outcome always involves joint venture formation. Given a market structure, we find that the optimal emission tax is always less than the marginal social damage. We then demonstrate that if the synergistic effect (SE) is large and the industry is neither very dirty, nor very clean, then the constrained first best outcome can be implemented by setting the abatement tax appropriately. Otherwise the constrained first best outcome cannot be implemented.