Measuring the Effects of Environmental Regulation in Oligopolistic Markets with Differentiated Products

Pollution emissions from vehicles have increased considerably in recent years in many Brazilian cities, causing significant health problems. As a response, environmental standards for automobile pollution were implemented in 1988, and considerable reductions in emissions were attained. Nevertheless, in 1997 substantial differences in emissions between car models still remained, suggesting the need for further regulation. This paper simulates the effects of a new environmental standard on the automobile market. Using a discrete-choice model of demand and disaggregated 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 taking into consideration 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. In addition a hedonic-cost function relating marginal cost to characteristics and emissions is estimated. Based on the results obtained and the 1997 emissions data, a counterfactual simulation of a new pollution standard for hydrocarbon vehicle emissions is undertaken. The results indicate that, given the existing technology, imposing a new standard of 0.15 grammes per kilometre for all automobiles would lead to an average price increase of 12% and a reduction in total sales of 31%. This would generate a 39% reduction in total HC emissions per kilometre driven, with a tax revenue loss of 16%. The paper concludes that, although substantial emissions reductions could be induced by a tighter standard, the welfare effects of such a policy requires further analysis