Resource and Energy Economics 26 (2004) 281–293
Can green consumerism replace environmental
regulation?—a differentiated-products example夽
Clas Eriksson∗
Department of Economics, Swedish University of Agricultural Sciences,
P.O. Box 7013, S-750 07 Uppsala, Sweden
Received 11 February 2002; received in revised form 3 October 2003; accepted 14 October 2003
Available online 28 January 2004
Abstract
This paper assumes that consumers are willing to pay an extra premium for a good if it has a
low impact on the environment. We examine if a little dose of such idealistic behavior has a large
impact on the market equilibrium, and to what extent it can replace the environmental regulation.
The analysis is carried out in a model with product differentiation, where consumers differ in their
preferences for product quality. Consumers’ willingness to pay the environmental premium may be
uniformly or non-uniformly distributed. Green consumerism will only be modestly influential in
both cases, despite the fact that product differentiation leads to relaxed competition and increased
profits, and thereby creates leverage.
© 2003 Elsevier B.V. All rights reserved.
JEL classification: D11; D43; O33
Keywords: Green consumerism; Product differentiation; Technology adoption
1. Introduction
In the late 1980s, many firms experienced that broad groups of consumers had become
willing to pay an extra premium for a product if it were green.1 During this wave of green
consumerism, firms realized that they could increase their profits by taking environmental
夽 I have benefited from discussions with Lars Hultkrantz, and from comments by seminar participants at The
Swedish University of Agricultural Sciences (Uppsala), Dalarna University, Luleå University and The Ulvön
Conference 2001. Furthermore, the comments from an anonymous referee have been very useful.
∗ Tel.: +46-18-67-17-55; fax: +46-18-67-35-02.
E-mail address: [email protected] (C. Eriksson).
1 In this paper, we will interchangeably say that production (or the technology) is “clean” or “green” (if it is not
“dirty”).
0928-7655/$ – see front matter © 2003 Elsevier B.V. All rights reserved.
doi:10.1016/j.reseneeco.2003.10.001
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C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
concerns seriously (Cairncross, 1992, Chapter 9). This paper examines to what extent these
increased profit opportunities could make environmental regulation less needed.
Although the notion of a green consumer is hard to find in standard microeconomics
textbooks, it is perfectly possible to reconcile him or her with the tool kit of economics,
by using the concept of altruism. In recent years, various branches of economic research
have developed and applied this concept, e.g. Bergstrom (1995) and Andreoni (1989). For
an environmental application, see Popp (2001).
Thus, there is some support for the notion of a green consumer from casual observation,
microeconomic theory, and perhaps introspection. We will therefore assume that consumers
act from a certain degree of idealism, and internalize some of the negative externalities from
the production of the goods that they buy. A possible consequence is that it is profitable for
firms to get “green” to an extent larger than required by actual regulation.
The central question is, however, whether the decentralized economy will come close
to a performance that is socially optimal. An affirmative answer is probably more likely
if there is some distortion that creates an amplifying effect. We know from other contexts
that distortions in a market might create some leverage. For example, imperfect competition in macroeconomic models frequently results in multiplier effects (e.g. Blanchard and
Kiyotaki, 1987). Moreover, the literature on environmental taxation indicates that there may
be “double dividends” from a “green” tax reform if there are initial, non-environmental, tax
distortions on the market that the reform helps eliminate (Bovenberg and Goulder, 2001).
Inspired by this, we investigate whether imperfect competition implies that low levels of
environmental idealism lead to considerable reductions in pollution.
Following the Hotelling (1928) tradition, we consider a duopoly industry, where the
products are horizontally differentiated. This is a way of relaxing competition and increasing
profits (Shaked and Sutton, 1982). In particular, the differentiation between clean and dirty
goods might contribute to less competition and higher profits, thus improving the incentives
to use a clean production technology.
Consumers perceive some additional utility when the good that they buy is clean. In
this way, some of the externalities are internalized. The degree of this internalization
may be uniformly or non-uniformly distributed over consumers. We find that green consumerism has very low influence in both cases. In the former, the decentralized economy
will choose green production, when it is socially optimal to do so, only if consumers
internalize the externalities entirely. In the latter, it is optimal for one firm to choose environmentally friendly production at quite low levels of consumer idealism. However, it
is optimal for the other firm to use the dirty technology at all interesting parameter values, since this contributes to keep firms differentiated, which renders profits. Thus, this
paper gives little support to the idea that green consumerism can replace environmental
regulation.2
The paper is organized as follows. Section 2 presents the building blocks of the model.
It derives expressions for demands and profits in Nash equilibrium and characterizes the
social optimum. In Section 3, the points at which it is optimal to switch to clean production
are analyzed. In particular, the market equilibrium is compared to the social optimum.
2 Nevertheless, green consumerism can still be a useful element, together with other instruments, in the process
of switching to cleaner production.
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283
2. Model
2.1. Consumers and firms
We use a simple model with product differentiation (e.g. Tirole, 1988), with two firms on
a market. Their products are found at different ends of a quality scale. Denote the position
on this scale by x, with firms 1 and 2 at x1 = 0 and x2 = 1, respectively. Consumers’ preferences for quality are uniformly distributed along this interval. The number of consumers is
normalized to unity and each of them buys either one or zero units of the good. A consumer
at x , buying quality x , perceives the utility loss b|x − x |. Total utility of a consumer at
x is
U = s − pi − b|x − xi | − ay + ∆af(x),
i = 1, 2
(1)
where s, a and b are constants. (If no good is consumed, U = 0.) The parameter s captures
the gross utility of consuming one unit. From this is deducted: (i) the price of the good; (ii)
the utility loss due to inadequate quality; and (iii) disutility of (aggregate) pollution, which
is given by
y(t) = [δ1 q1 (t) + δ2 q2 (t)],
i = 1, 2
(2)
where q1 and q1 are quantities produced by the two firms and a is the marginal disutility
of pollution. If firm i uses the polluting technology, then δi = 1 and δi = 0 if it uses the
clean production technology.3 (If both firms use the dirty technology, y = 1.) Finally, we
add ∆af, where ∆ = 1 if the consumer buys a clean good, and ∆ = 0 if the consumer buys
a dirty good.
Since a single consumer cannot perceptibly influence y, he treats the term −ay as a
constant. However, consumers act from “idealism” and perceive some utility from knowing
that they do not contribute to pollution, even though each individual knows that the effect of
his choice is negligible; they simply experience a “warm glow” from “doing their bit”. This
partial and atomistic internalization of externalities is captured by the addition of the term
af to the utility function, when the consumer is buying a ‘’clean” good. The function f is
f(x) = α + βx,
α, β > 0
(3)
In Fig. 1, consumers with higher x get more additional utility when buying a clean good than
consumers with low x. For simplicity, I assume a perfect correlation between preference for
quality and degree of idealism, so that they can be captured by one variable only.4 To interpret
this, consider the case of laundry detergents. Assume that low x means that the color is kept
intact after cleaning, while the smell of the clothes is not perfectly fresh. At high x the odor
is perfect, but the colors bleach. Making f an increasing function of x means that there is a
simple relationship between consumers’ willingness to accept bleaching and their idealism.
If β = 0, the environmental concern is spread uniformly, at the level α. If, in addition, α =
1 then all individuals take full responsibility for their contribution to pollution and internalize
3
It should be clear that the firms produce the same good, except from differences in quality.
Alternatively, one could make the preference space two-dimensional (Arora and Gangopadhyay, 1995; Cremer
and Thisse, 1999). This would be a way to increase realism at the expense of transparency of the analysis.
4
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C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
Fig. 1.
externalities entirely. However, since we want to see whether low levels of idealism can
have large influences on market equilibrium, we assume that the surface below f does not
cover more than half the unit square: α + β/2 ≤ 1/2. Can the market equilibrium be close
to socially optimal even though no more than half the externality is internalized?
To answer this question, we must first describe equilibrium prices, quantities and profits
when 0,1 or 2 firms adopt the green technology (hereafter: just “adopt”). Starting with
the middle case (which we call the asymmetric equilibrium), the other two (symmetric
equilibria) follow easily. Assume, for sake of definiteness, that only firm 2 adopts. The
individual who is indifferent between the products of the two firms is found at x̂, defined by
s − p1 − bx̂ = s − p2 − b(1 − x̂) + a(α + βx̂)
(4)
where the “warm glow” term is only added on the right hand side, because only firm 2 is
clean. Solving this equality of utilities, we find the indifferent individual at
x̂ =
p2 − p1 + b − aα
.
2b + aβ
(5)
Individuals to the left of this point buy the product from firm 1 and individuals to the right
buy from firm 2.5 Since population is normalized to unity, the demand functions are
b + p2 − p1 − aα
and
2b + aβ
b + p1 − p2 + a(α + β)
.
q2 = D2 (p1 , p2 ) = 1 − x̂ =
2b + aβ
q1 = D1 (p1 , p2 ) = x̂ − 0 =
5
(6)
We assume that s is high enough for the market to be covered, i.e. every consumer buys one unit of the good.
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285
These functions will now be substituted into the profit functions of the two firms, in order
to derive prices, demands and profits in Nash Equilibrium.
2.2. Nash equilibrium
The (constant) unit costs of production in the clean and dirty industries, respectively, are
cD = c and cC = c + γ, where γ ≥ 0. The profit functions in the asymmetric equilibrium
are Π 1 = (p1 − cD )D1 (p1 , p2 ) and Π 2 = (p2 − cC )D2 (p1 , p2 ). We use Eq. (6) in these
functions and assume that each firm maximizes profits with respect to its own price, taking
the other price as given. This renders two reaction functions6 , which are solved for Nash
Equilibrium
pc1 = c + b +
γ + a(β − α)
3
and
pc2 = c + b +
2γ + a(2β + α)
.
3
(7)
As in the basic model of product differentiation, prices exceed costs when b, the marginal
disutility of inadequate quality, is positive. Furthermore, the additional cost for clean production (γ) raises the equilibrium price of the clean firm (pc2 ), but not by the entire cost
increase: it also creates a possibility to increase the price of the dirty good. Finally, consumer idealism contributes to a higher pc2 , whereas the effect on the price of the dirty good is
ambiguous. The more unequal the distribution of voluntary internalization of externalities
(the higher β) the more likely it is that the dirty firm can benefit as well. This is because
there is more heterogeneity among consumers, which both firms can explore to increase
profits.
Substituting these prices into Eq. (6), we obtain the demand functions
D1 =
1 2γ − a(β + 2α)
+
2
12b + 6aβ
and
D1 =
1 a(β + 2α) − 2γ
+
.
2
12b + 6aβ
(8)
These demands deviate from 0.5 equally much, in opposite directions. The dirty firm benefits
from the higher cost in the clean firm, while the clean firm benefits from consumer idealism.
Finally, Eqs. (8) and (7) are substituted into the profit functions, to yield
b 3b(4γ + a(β − 4α)) + 2(γ + a(β − α))2
+
and
2
18(2b + aβ)
b 3b(−4γ + a(5β + 4α)) + 2(−γ + a(2β + α))2
2 = +
2
18(2b + aβ)
Π1 =
(9)
The b/2 terms represent the traditional profits due to product differentiation, as discussed
in Shaked and Sutton (1982). The last RHS terms capture positive or negative profits increments due to differences in cleanliness. Firm 1 benefits from a higher γ, as opposed to firm
2. The more heterogeneous consumer idealism is (high β, low α) the higher is Π 1 . Firm 2,
on the other hand, experiences a higher profit from increases in both β and α.
Having solved for prices, quantities and profits when just one firm adopts, it is straightforward to derive corresponding expressions for the symmetric equilibria. If firm 1 adopts
6
The reaction functions are p1 = (b + p2 + cD − aα)/2 and p2 = (b + p1 + cC + a(α + β))/2.
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C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
as well, the term a(α + βx) vanishes from Eq. (4), so α and β do not occur in the expressions
following Eq. (4). For both firms, c + γ replaces c in the earlier expressions, whereas all
other terms containing γ vanish in Eqs. (7)–(9). In this symmetric equilibrium, both firms
have
1
b
and Π 0 = .
(10)
p0 = c + γ + b, D0 =
2
2
By similar reasoning, this is also the price (without γ), demand and profit for each firm
when none adopts. The firms are indifferent between jointly adopting and jointly refraining
from adoption, because they are able to burden consumers with the entire cost increase of
adoption. The profit Π 0 can always be achieved by making the same technology choice as
the rival.
2.3. Social optimum
To compare the market outcome with the social optimum, we formulate the social welfare
function (see Appendix A). By symmetry, it is optimal that both firms either use the dirty
technology or that they both use the clean technology. The critical cost difference is
γ = a.
(11)
The optimal social decision rule is to use the clean technology if and only if the cost
difference is not larger than the benefit from avoided pollution.
3. Comparing decentralized equilibrium and social optimum
To see whether the private solution implies that clean production is chosen, when it is
socially optimal to do so (or at least comes close to that), we examine the profit and demand
functions at different relations between the cost-difference parameter (γ) on the one hand
and the “consumer idealism” parameters (α and β) on the other. We start with the uniform
case and then continue with the non-uniform case.
3.1. Uniform concern for the environment
At a uniform concern for the environment β = 0, so the demand functions in the asymmetric equilibrium Eq. (8) simplify to
D1 =
1 γ − aα
+
2
6b
and
D2 =
1 −γ + aα
+
.
2
6b
(12)
Firms only participate in equilibria with non-negative sales: D1 ≥ 0 and D2 ≥ 0. Using
these conditions, we get: aα − 3b ≤ γ ≤ aα + 3b. In Fig. 2, we find the combinations
of α and γ that satisfy these inequalities in regions 2 and 3. Only here should we look for
asymmetric equilibria but we may have symmetric equilibria in this region as well. Before
examining regions 2 and 3 closer, we summarize our findings about regions 1 and 4: (The
initial statements on demands would hold in an asymmetric equilibrium).
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287
Fig. 2.
Region 1. D1 = 1, D2 = 0. If firm 2 adopts, it loses all customers and profits, while firm
1 takes the entire market, because the degree of idealism among consumers (α) is small
compared to the cost increase of switching to green production, γ. Therefore, no firm will
use the green technology if parameters are found in this region.
Region 4. D1 = 0, D2 = 1. Firm 2 would take all sales and profits, if firm 1 did not
adopt, but the best choice of firm 1 is to adopt as well, thereby increasing profits from
0 to Π 0 . Adopt is thus a dominating strategy for both firms, so there is no pollution. The
reason is that it is not expensive to switch to clean production, while consumers significantly
reward it.
To determine the outcomes in regions 2 and 3 we examine profits. When 0 or 2 firms
adopt, they are Π 0 = b/2. Since β = 0, the profits when only firm 2 adopts Eq. (9) are
Π1 =
b (γ − aα)(6b + γ − aα)
+
2
18b
and
Π2 =
b (aα − γ)(6b + aα − γ)
+
2
18b
(13)
The relative magnitudes of Π 0 , Π 1 and Π 2 determine the technology choices. There are
three lines in (α − γ)-space at which there are switches in these relations. These lines are
given by the points at which any of the factors in the numerators of the last terms in Eq. (13)
are equal to zero. For example, Π 2 = Π 0 when γ = 6b + aα. However, such a line would
be found in region 1, in which we have concluded that no firm adopts. Similarly, the line
γ = −6b + aα (at which Π 1 = Π 0 ) would be found in region 4, where both firms adopt.
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C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
The only line that we mark out comes from the remaining condition for a switch, γ = aα,
where Π 1 = Π 2 = Π 0 . This is the dividing line between Regions 2 and 3 in Fig. 2. By
Eq. (13), firm 1 has higher profits than firm 2 in region 2, while the opposite holds true in
region 3. Our findings about regions 2 and 3 are (the initial statements hold for an asymmetric
equilibrium):
Region 2. 0 < D2 < D1 < 1; Π 2 < Π 0 < Π 1 . Compared to a situation with no adoption,
the adopting firm loses, while giving the non-adopting firm an increased-profit gift.7 There
will thus be no adoption of the clean technology in this region.
Region 3. 0 < D1 < D2 < 1; Π 1 < Π 0 < Π 2 . Firm 2 adopts, no matter what it believes
about firm 1’s reaction, because it can never get a profit lower than Π 0 . The reasons are that
consumers here are highly willing to carry (some of) the extra cost of green production and
that the cost difference is quite small. The best response from firm 1 is however to adopt as
well, so the economy will have an equilibrium without any pollution.
Pollution is thus likely to be avoided when the values of γ and α place us in regions
3 and 4. But how likely is it that these regions are reached at modest levels of consumer
idealism, which, by Fig. 1, means that α ≤ 1/2? The minimum requirement for total adoption is α = γ/a (the border between regions 2 and 3). This condition can be fulfilled at
low levels of idealism, if the cost difference is small compared to the disutility of the externality. However, by Eq. (11) it is socially optimal to switch to green production when
γ/a = 1. In other words, it is required that consumers voluntarily internalize the externality entirely (α = 1) if the decentralized economy is going to take the role of the social
planner.
This might be disappointing for those who believe that green consumerism can be an important power in society. On the other hand, it seems to be expecting too much that consumer
idealism could replace environmental policy entirely. Furthermore, policy actions can be
lacking, although they are socially optimal, due to political failures or asymmetric information (Xepapadeas, 1991). A possible interpretation is therefore that green consumerism
might be almost as powerful as environmental regulation.
The result obtained here may however depend on the assumed uniform concern for the
environment, since this excludes an heterogeneity of consumers that firms could explore to
increase profits. Therefore, we now turn to the case where f varies with x.
3.2. Non-uniform concern for the environment
A situation where some consumers voluntarily internalize externalities to a larger extent
than others is in the present model found when β > 0. To emphasize this heterogeneity, we
7 However, one can easily see that 2Π 0 < Π 1 + Π 2 , which can be interpreted as a joint profit gain because
of “green” differentiation. Since firms realize that they can both benefit from an adoption by one of them, some
“co-operation” might arise. For example, they may both give a contribution to a fund that supports the adoption
of green technologies, from which the adopting firm obtains a subsidy. However, while this is a possible outcome,
it is likely that it will be deemed illegal. We will take this to be the most likely case.
C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
289
Fig. 3.
assume that α = 0. The demand functions in Eq. (8) then become
D1 =
1
2γ − aβ
+
2 12b + 6aβ
and
D2 =
1
−2γ + aβ
+
.
2 12b + 6aβ
(14)
To have non-negative quantities in both firms, we again use the conditions D1 ≥ 0 and
D2 ≥ 0 and find that γ must now be in the interval −3b − aβ ≤ γ ≤ 3b + 2aβ. Since
we are only interested in non-negative values of γ and β, the only interesting border in (β,
γ)-space is γ = 3b + 2aβ, which separates regions 1 and 2 in Fig. 3.8 Our findings about
region 1 are:
Region 1. D1 = 1, D2 = 0. An asymmetric equilibrium would here mean that firm 2 lets
firm 1 take all sales and profits. Thus, firm 2 will not adopt the clean technology here, so
both firms use the dirty technology.
To understand the choices in the remaining regions, we examine the profits. If 0 and 2
firms respectively adopt, they still are Π 0 = b/2 for each firm. In the case when only firm
2 adopts, the assumption that α = 0 modifies Eq. (9) to
Π1 =
b f
+ ,
2
h
and
Π2 =
b g
+
2 h
(15)
8 The line γ = −3b − aβ would be found in the second quadrant and is therefore not marked out; we are only
interested in situations where it is cheaper to use the dirty technology.
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C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
where f ≡3b(4γ + aβ) + 2(γ + aβ)2 , g≡3b(5aβ − 4γ) + 2(−γ + 2aβ)2 and h≡18(2b + aβ).
The final terms of these profit expressions define switching points of relative profits. First,
there are two borders in (β, γ)-space at which f = 0(Π 1 = Π 0 ) and g = 0(Π 2 = Π 0 ).
Since f and g are second order polynomials, we readily solve these equations. Two solutions
are ruled out since they imply uninteresting parameter values.9 The interesting solutions
are
√
8γ − 15b + 3b 25 + 16γ/b
(16)
β|g=0 =
16a
and
γ|f =0 =
−(12b + 4aβ) +
(12b + 4aβ)2 − 8aβ(3b + 2aβ)
4
(17)
By Eq. (17), the combinations at which f = 0 are solely found in the second quadrant of
Fig. 3, i.e. Π 1 < Π 0 only at negative values of γ. Thus, firm 1 will never choose the clean
technology. Thereby it takes the opportunity to raise profits, arising from the heterogeneity
that the positive β creates. The curve representing Eq. (16) is found further to the right in
the figure; Π 2 > Π 0 to the left of this curve, which can be at rather high values of γ.
A final border is found where g = f(Π 1 = Π 2 ). Using the definitions of f and g above,
this equality yields another second-order polynomial. The interesting solution is
−(6b − 4γ) + (6b − 4γ)2 + 144bγ
β|g=h =
(18)
6a
To the left of this border (i.e. at lower γ and higher β), the profit of the adopting firm is
higher than that of the non-adopting firm in the asymmetric equilibrium.
To see whether the decentralized market can (almost) take the same environmental responsibility as a social planner, we start by commenting the regions of in Fig. 3. (The initial
statements about profits would hold at an asymmetric equilibrium.)
Region 2. Π 2 < Π 0 < Π 1 . Firm 2 will lose from adoption, while firm 1 will get a profit
that is higher than it would be in a situation where there is no adoption at all. Firm 2 will
not adopt and the result is that both firms use the dirty technology.
Region 3. Π 1 > Π 2 > Π 0 . Both firms benefit if firm 2 adopts while firm 1 uses the dirty
technology. A total switch to green production is therefore not likely, but firm 2 is probably
willing to adopt since the profit then rises above Π 0 .
Region 4. Π 2 > Π 1 > Π 0 . As in region 3, both firms benefit if only firm 2 adopts. Firm
2 should be even more willing to accept this solution here than in region 3.
Region 5. Π 1 < Π 0 < Π 2 . Both firms have adopt as a dominating strategy, firm 1 because
the profit will fall below Π 0 otherwise. Thus, there will be no pollution. As already noted,
however, in this region γ < 0, which is not an interesting case.
9 The second root of Eq. (16) would be represented by a curve in Region 1; the second root of Eq. (17) implies
that γ is significantly below 0, for all β > 0.
C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
291
The difference between Figs. 2 and 3 is that the three curves f = 0, g = 0 and f = g of
Fig. 3 collapse to one curve, γ = aα, in Fig. 2. Thus, regions 3 and 4 of Fig. 3 do not exist in
Fig. 2, and region 5 in the former corresponds to region 3 in the latter. At a uniform concern
for the environment, there was a total switch from maximum pollution to no pollution at
one point. Here, green production is at best partial, in regions 3 and 4.
To see what it takes to make the economy enter region 3, so that the greening of production
at least gets started, we use the second-order Taylor expansion of Eq. (16) around 0:
β|g=0 ≈
4γ
12 1
− √ γ 2.
5a
5 5a
(16b)
Since we have concluded that at most one firm will use the clean technology at interesting
parameter values, the question we now pose is rather modest in comparison with the one
we started out with: what is the value of β at which one firm switches to clean production,
when it is socially optimal that both firms do so? An answer is given if we use a = γ in
Eq. (16b)
β|g=0 ≈
4
12
− √ γ
5 5 5
(16c)
Recall from Fig. 1 that a modest level of idealism requires that β ≤ 1 when α = 0. By
Eq. (16c), β is always below 1 and significantly so, if γ is not very small. Thus, one firm
chooses the clean technology at very low levels of consumer idealism. This is an instance
of the fact that differentiation with respect to cleanliness generates profit opportunities.
However, the clean firm may have just a small part of total production, leaving the major
part to the dirty firm. Keeping the environmental ambitions at a middle level we ask the
question: what does it take in terms of idealism to make half the production clean, when it
is socially optimal to switch entirely? Using Eq. (14), we find that D1 = D2 ⇔ aβ = 2γ.
By the optimality condition a = γ, the answer is that β = 2, which violates the assumption
that β ≤ 1. In other words, a modest degree of idealism does not lead half the way to
the social goal. Again the conclusion is that one can hardly rely (entirely) on the market
and idealistic consumers even to get close to the social environmental goal. To be sure, the
unregulated market is rather inclined to start the adjustment toward clean production, but
there are also strong incentives to prevent this adjustment process from being completed,
because differentiation in the environmental dimension is a source of profits.
4. Concluding discussion
This paper analyzes to what extent partial and voluntary internalization of negative environmental externalities can replace public interventions in a duopoly market. It seems that a
modest degree of idealism cannot replace environmental regulation. When the willingness
to pay an environmental premium is homogenously distributed, the decentralized market
chooses green production, at a socially optimal point, only when consumers voluntarily
internalize externalities entirely. When idealism is unevenly distributed, one firm ‘’goes
green” at low levels of idealism, because differentiation with respect to cleanliness relaxes
competition and increases profits. For the same reason, however, the other firm will not
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C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
follow; the profits from ‘’environmental differentiation” would disappear if it did. Public
intervention is therefore needed to come to grips with environmental degradation in this
form of market.
Further research should examine how the results change under more general assumptions
than we have used here. For example, in reality many markets have more than two competing firms, not least in the markets where green consumerism was first noted, e.g. laundry
detergents and (bleached versus non-bleached) paper. Raising the number of firms in the
model, we should expect a downward pressure on profits. Therefore, there would probably
be less to gain by differentiation in the green dimension. In other words, such a step toward
increased competition would probably reinforce the conclusion that green consumerism
does not create much of a leverage for the benefit of the environment. It would also be
interesting to allow for non-linearities in the cost and utility functions. While this is likely
to change the magnitudes of crucial switching points, our conjecture is that it would not
change the basic results of the paper.
One could also make the game dynamic, allowing for the possibility of preemption, as
in the works on ‘’timing games”, e.g. Fudenberg and Tirole (1985) and Katz and Shapiro
(1987). Then, there would probably be a value in being first as a green producer when the
cost of adopting a green technology is falling over time, which might imply that it comes
into use much earlier than in the static setting. On the other hand, it could be argued that if
we bring in time we should also bring in uncertainty. This is likely to delay the adoption of
the green technology, because of the “option value of waiting” (Dixit and Pindyck, 1994).
The total effect would therefore be ambiguous.
The model is connected to several interesting policy issues. For example, it suggests that
there is a potential role for promoting education about environmental impacts, since this
may change preferences so that externalities are internalized to a larger extent. Although
we have seen that this is not sufficient, it might be a useful ingredient in the process of
solving environmental problems. For example, it could be combined with subsidies to
green production, which would in effect lower the γ perceived by the firms in our model.
If such measures are likely to meet less of political resistance than direct regulation against
the dirty technology (which would explicitly force behavior upon households and firms)
they constitute an alternative that should be taken into serious consideration.
Is much or little heterogeneity in consumer idealism to be preferred? From Section 3.2, it
seems that the environment benefits only partially when a (small) subset of the population
cares much about the environment, whereas the rest cares little. In contrast, less heterogeneity makes it more likely that both firms switch to clean production, if consumer idealism
is high enough. Therefore, if ambitions are high, education campaigns should be directed
primarily toward the less idealistic consumers, with the purpose of making consumers more
homogenous with respect to environmental idealism. Combining this with green production
subsidies, a total switch to green production may become possible.
Appendix A. Social optimum
Social welfare is the sum of utilities over all individuals. Denote by xs the individual that
should be indifferent between the two goods in social optimum. Both firms either use the
C. Eriksson / Resource and Energy Economics 26 (2004) 281–293
293
dirty technology or they both use the clean technology. In the former case, social welfare is
xs
1
W=
(s − p − b(v − 0) − ay)dv +
(s − p − b(1 − v) − ay)dv
xs
0
b
= s − p − ay −
1 − 2xs + 2(xs )2 .
2
(A.1)
where the bracket is minmized at xs = 1/2. The optimum is thus symmetric and
W =s−p−
b
− ay
4
(A.2)
In optimum, price equals cost. At dirty production, y = 1 and social welfare is equal to
WD = s − c − a − (b/4). At clean production, y = 0, but production costs increase by γ,
so welfare is WD = s − c − γ − (b/4). These expressions are equal when γ = a.
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