Oligopolies with (Somewhat) Environmentally Conscious Consumers: Market Equilibrium and Regulatory Intervention

• Author: Madhu Khanna,George Deltas,Donna Ramirez Harrington
• Published date: 01 September 2013
• DOI: http://doi.org/10.1111/jems.12019
• Date: 01 September 2013

Oligopolies with (Somewhat) Environmentally

Conscious Consumers: Market Equilibrium and

Regulatory Intervention

GEORGE DELTAS

University of Illinois

1206 South Sixth Street, Champaign IL 61820

deltas@illinois.edu

DONNA RAMIREZ HARRINGTON

University of Vermont

Old Mill Building, Burlington VT 05405

djramire@uvm.edu

MADHU KHANNA

University of Illinois

1301 W. Gregory Drive,

Urbana IL 61801

khanna1@illinois.edu

We consider a horizontally differentiated duopoly where consumers care about the product’s

“greenness.” Firms can be asymmetric: they may differ in the product’s intrinsic value and

may also differ in their chosen level of greenness. We examine the choice of greenness and the

implications of various policy interventions. We show that (i) the choices of product greenness

are strategic substitutes, (ii) the high-intrinsic quality firm produces the greener product, (iii)

the low-quality firm’s greenness may increase with the cost of its provision or decrease with

consumer willingness to pay for it, (iv) a minimum quality standard (MQS) leads the greener

firm to lower its environmental quality and can even reduce average quality, (v) greenness is

underprovided even if consumers fully internalize the externality, and (v) an MQS can reduce

welfare if the greenness of the high-quality firm exceeds the MQS, even when environmental

quality is underprovided. The effects of policy interventions on profits differ qualitatively across

polices and firms: A firm that lobbies for one type of intervention may lobby against another

We thank Amy Ando, Marcus Asplund, Greg Leblang, Dan Bernhardt, Jay Pil Choi, Carl Davidson, Gre-

gory Kordas, Chistopher Laincz, Ming Li, Damba Lkhagvasuren, Vibhas Madan, Adam Rennhoff, Lambros

Pechlivanos, Konstantinos Serfes, John Wilson, Alex Winter-Nelsonand seminar participants at the American

Economic Association Annual Meetings, Concordia University,Drexel University,the Heartland Environmen-

tal and Resource Economics Conference (Iowa State University), the International Industrial Organization

Conference, the Midwest Economic Theory Conference, Michigan State University,the Program for Environ-

mental and Resource Economics of the University of Illinois, Conference for Researchin Economic Theory and

Econometrics (CRETE), the Society for the Advancement of Economic Theory (SAET) bi-annual conference,

and the University of Guelph for helpful comments and discussion. Financial support from the Environmental

Protection Agency STARprogram grant no. R830870 is gratefully acknowledged. Feedback from an Associate

Editor and two anonymous referees has substantially improved this paper.

C2013 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume22, Number 3, Fall 2013, 640–667

Environmentally Conscious Consumers 641

similar one, and a firm may lobby for an intervention while its competitor may lobby against it.

A subsidy for the development costs of a green product can financially hurt both firms.

1. Introduction

The development of green products is emerging as a strategy for reaching out to increas-

ingly environmentally conscious consumers, with the intention of capturing a price pre-

mium, increasing market share, or both. Willingness to pay for environmentalattributes

through product choice arises for reasons that range from purely private motives (en-

hanced health/safety,energy savings) to purely altruistic motives and ideas of personal

responsibility (e.g., recycling, dolphin safe tuna). Green products, such as nonanimal

tested products, recyclable and refillable containers, ultraconcentrated detergents and

fabric softeners, recyclable batteries and energy efficient cars/appliances compete with

conventional ones and experience increasing demand.1Products differ not only in terms

of their environmental attributes (or “greenness”), but also in intrinsic product quality

(e.g., safety and reliability) and in other attributes (e.g., design, style, brand, and conve-

nience). Some of the product attributes, such as “greenness” and intrinsic quality, can be

considered vertical attributes, that is, no consumer finds them undesirable. Consumer

preferences for horizontal attributes, such as design and style, differ: what one consumer

finds desirable, another consumer may find undesirable.2Because typically there do not

exist products of all possible configurations, a consumer may choose a less green product

over a green one (of the same price) if the other attributes of the former are more valued

by this consumer than those of the latter product. The benefits to a firm of increasing

the greenness of its product rise with the value that consumers attach to greenness as

an attribute and with the degree of substitutability between its product and that of its

rivals. These benefits must be balanced against the costs of increasing greenness. In an

oligopolistic environment a firm must also consider any adverse competitive reaction

by its rivals when choosing the greenness of its product. This adverse reaction could

take the form of an increase in the greenness of the rivals’ products, or of lower prices

of the rivals’ existing products, or both.

In this paper, we focus on the following four issues. First, we investigate whether

firms with high-intrinsic quality products would choose to produce more or less envi-

ronmentally friendly products than their competitors. Second, we investigate how the

environmental quality of the firms’ products responds to (a) increased consumer will-

ingness to pay for greener products or, equivalently, a tax on a polluting attribute of

the products, (b) a cost-sharing of the development costs for improving the greenness

of a firm’s product (or, equivalently, a secular technical change that reduces the devel-

opment costs of green products), and (c) a minimum environmental quality standard

(MQS). Third, we examine the effect of the above three changes on equilibrium prices

and firm profits, which would determine whether the firms would welcome or oppose

such changes. Fourth, we examine the effects of these public policies on welfare and on

the average value of the environmental attribute.

1. For a discussion of the demand for hybrid cars see Greenwire, 25 March 2003. A Gallup study found

that 65% of Americans, 59% of Germans, and 31% of Japanese were willing to pay a premium for eco-safe

products (Simon, 1992). For further discussion see Reinhardt (2000).

2. Indeed, amongst all attributes, greenness is probably not the most important one; surveys show that

only 14% of Americans regularly bought products because of recycled content or refillable packaging in 1990

(Simon, 1992).