Market size asymmetry and strategic environmental policy in a Cournot model

Abstract

The achievement of Sustainable Development Goals (SDG) related to the environment requires identifying new sources of environmental degradation. This paper analyzes how market size asymmetry affects government decisions on environmental policy in the context of bilateral international trade and imperfect competition. We model an international duopoly with market size asymmetry and product heterogeneity. Each firm produces two different products, one for the domestic and one for the foreign markets, where the firms' production generates local emissions. When planning policies, the government in each country must choose between two options: an emission tax or a production subsidy. The findings of our paper underline the crucial role of market size asymmetry in determining the non-cooperative equilibrium policy in a setting where both firms and governments act strategically. We find that an increase in market size asymmetry between countries encourages governments to shift from emission taxes to production subsidies. Therefore, the environmental policy must consider these aspects to achieve greater effectiveness of regulation in favor of the environment. Actions to mitigate increased pollution should regulate production subsidies and improve the practices of governments and companies.