Microfoundations for the Environmental Kuznets Curve: Invoking By-Production, Normality and Inferiority of Emissions

A by-production-cum-preference based approach is adopted to study the relation between national income and environmental quality under non-cooperative behaviour. While emission is an inferior good for richly endowed economies, it is a normal good for the developing economies. With increases in endowments, the marginal willingness to pay declines (respectively, increases) in the set of poorly (respectively, richly) endowed economies. Hence, for emissions, the income and substitution effects work in opposite directions. Abatement strategies include cleaning-up; decreases in and substitution between fuels of varying costs, emission, and energy intensities; and the diversion of capital from fuel-intensive to non-fuel intensive uses. Poorly (respectively, richly) endowed economies are characterized by weak (respectively, strong) environmental policies. Consequently, deteriorating abatement practices are adopted by the developing economies. The shape of the income-environmental quality graph depends on the relative strengths of income and substitution effects and the set of available abatement strategies. Both inverted U and N-shaped environmental Kuznets curves are possible. The latter arises due to stronger substitution effects and lower opportunity costs of fuel-intensive capital in the more richer of the richest economies.