The Impact of Environmental Taxes on Firms' Technology and Entry Decisions

This paper investigates under which conditions a regulator can strate- gically set an emission fee as a tool to induce a domestic firm to adopt a non-polluting technology and deter entry. We consider a market in which a monopolistic incumbent faces the threat of entry from firms that can choose between a dirty and a green technology. Our results show that, despite the fact of facing a polluting incumbent, an entrant might find it profitable to acquire a clean technology if the environmental tax is strin- gent enough. In addition, we demonstrate that an incumbent that adopts a clean technology is more likely to deter entry than an incumbent that keeps its dirty technology. Finally, we also show that a non-polluting duopoly market, in which all firms acquire clean technology, is socially preferred to a non-polluting monopoly market if the green technology cost is sufficiently low. However, if the clean technology becomes more expensive it may be socially optimal to have a polluting duopoly market in which only one firm adopts the green technology.