Endogenous subsidies for cleaner products: The role of ecofriendly consumers

In a vertically differentiated duopoly, we assume that environmental subsidies are endogenously determined by the demand for dirtier goods and the relative greenness of cleaner alternatives. By contemplating the possibility that a subsidy targets either consumers or firms, we study how the impact of a subsidy changes with its recipients, consumers versus firms. A consumer‐based subsidy is environmentally enhancing and increases firms' profits at equilibrium, while it hurts consumers. Overall, however, it is welfare improving. A firm‐based subsidy makes firms better off but may be environmentally harmful and has the paradoxical effect of hurting consumers buying the cleaner variant. Moreover, it is welfare detrimental on the whole.