Environmental quality competition and eco-labeling

A three-stage game including investments, environmental quality provision and price competition is developed to study the impact of green technology investment (ecolabeling), in a duopoly model of vertical product differentiation. The firms’ incentives to invest in green technologies depend on their relative cost structure. When firms are identical with respect to fixed costs, both firms will always invest, but if one firm is more efficient in investing, then the other firm may or may not invest depending on the level of unit cost of investment. Quality competition will be tighter when the low quality firm is more efficient, and looser when the high quality firm is more efficient in investing. Socially optimal investment for both firms is always positive, but lower than in the duopoly solution. In the absence of environmental externalities, the quality dispersion chosen by profit maximizing firms may be too high or too low, while environmental externalities increase the possibility of too low quality dispersion in the market solution. Finally, and importantly, ecolabeling can be used as a means of reducing excessive investment and increasing too low environmental quality.