Determination of efficient environmental policy instruments under uncertainty with the dominant firm model

This paper reveals what the optimal environmental policy instruments under uncertainty are when there is one mighty (dominant) firm in a group of firms that produce homogeneous products. We extend and improve the research findings of Weitzman (1974). A dominant firm affects the decision making of other fringe firms. In this paper, we look at a case where a regulator implements environmental policy instruments, such as taxes or a quota, by focusing predominantly on the dominant firm. This paper estimates efficient policy by examining the deadweight loss caused by integrating the marginal abatement cost (MAC) to the marginal damage (MD). We set two parameters to measure the slope of the MD and that of the MAC for the fringe firms against that of the MAC for the dominant firm. This is done to estimate efficient policy and its preconditions. Consequently, the regulation adversely impacts each firm in the dominant firm model. Tax regulation is superior to the implementation of a quota when the slope of the MAC is equal to that of the MD, whereas the two policies have the same effect under the same conditions in the study by Weitzman (1974). Additionally, a quota policy is preferred when the MAC for the fringe firms is flatter than that of the dominant firm in contrast to the study by Weitzman (1974).