Measuring the Effects of Environmental Regulation in Oligopolistic Markets with Differentiated Products : The Case of Car Pollution in Brazil

Pollution emissions from mobile sources have increased considerably over the past years in many Brazilian cities generating substantial health problems. As a response, automobile pollution environmental standards were implemented in 1988 and considerable emission reductions were attained. Nevertheless, substantial differences in emission still remained among car models in 1997, suggesting the need for further regulation. This paper simulated the effects of a new environmental standard on the automobile market. Using a discrete-choice model of demand and disaggregate data on the Brazilian car market from 1993 to 1997, we estimate own and cross-price elasticities for each car model. This estimation is undertaken using a nested-logit model considering the choice between car classes and nationality. An oligopoly framework with differentiated products is used in the supply side in order to estimate unobserved marginal costs. Further, a hedonic-cost function relating marginal cost to characteristics and emissions is estimated. Based on the results obtained and the 1997 emission data, we undertake a counterfactual simulation of a new pollution standard for hydrocarbons vehicle emissions. The results indicate that imposing a new standard of 0.15 gram per kilometer for all automobiles, given the existent technology, would generate an average increase in prices of 13% and a reduction in total sales of 31%. This would generate a reduction in total HC emissions, by kilometer driven, of 39% with a tax revenue loss of a 16%. The paper concludes that although substantial emission reductions could be induced by a tighter standard, incentives for innovations on low-cost emission control devices and the welfare effects of such a policy deserve further analysis