Curbing Emissions: Environmental Regulations and Product Offerings Across Markets

Abstract

Problem definition: In the U.S. auto market, the California Air Resources Board (CARB) implements a stricter fuel economy standard in California than the federal standard implemented by the U.S. Environmental Protection Agency (EPA). The Trump administration’s 2018 announcement to freeze the EPA standard threatened to widen its gap from the CARB standard and cause a split market where automakers offer differentiated car models in CARB and non-CARB states. Inspired by this crisis, we investigate three research questions: when is market unification (all vehicles meeting a common efficiency standard) attainable? Is unifying a split market likely to reduce total CO2 emissions? If so, what strategies can help unify the market when unification does not occur naturally? Methodology/results: We adopt a game-theoretic model where two regulators with different levels of environmental awareness set efficiency standards in their respective markets, a firm offers product(s) for these markets, and consumers make purchases. We find that there exist cases where the firm offers a unified product for both markets, a different product in each market, or only serves one market, and our analysis suggests that unifying a split market may help curb emissions. We then propose and show that horizontal negotiations (between the regulators) and vertical negotiations (between a regulator and the firm) are potentially effective strategies to unify a split market and reduce emissions. Managerial implications: Our findings show that a more environmentally aware regulator can leverage its market power and reduce CO2 emissions outside its jurisdiction through negotiations. Furthermore, our findings suggest that the regulator should prioritize horizontal negotiations while using vertical negotiations as a back-up option. Supplemental Material: The online appendices are available at https://doi.org/10.1287/msom.2022.1141 .