Limit pricing, climate policies, and imperfect substitution

Gerard van der Meijden*, Cees Withagen

*Corresponding author for this work

Research output: Contribution to JournalArticleAcademicpeer-review

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Abstract

The effects of climate policies are often studied under perfect competition and constant marginal extraction costs. In this paper, we allow for monopolistic fossil fuel supply and more general cost functions, which, in the presence of perfectly substitutable renewables, gives rise to limit-pricing behavior. Four phases of supply may exist in equilibrium: sole supply of fossil fuels below the limit price, sole supply of fossil fuels at the limit price, simultaneous supply of fossil fuels and renewables at the limit price, and sole supply of renewables at the limit price. The consequences of climate policies for initial extraction depend on the initial phase: in case of sole supply of fossil fuels at the limit price, a renewables subsidy increases initial extraction, whereas a carbon tax leaves initial extraction unaffected. With simultaneous supply at the limit price or with sole supply of fossil fuels below the limit price, a renewables subsidy and a carbon tax lower initial extraction. Both policy instruments decrease cumulative extraction. If fossil fuels and renewables are imperfect but good substitutes, the monopolist will exhibit ‘limit-pricing resembling’ behavior, by keeping the effective price of fossil close to that of renewables for considerable time.

Original languageEnglish
Article number101118
Pages (from-to)1-14
Number of pages14
JournalResource and Energy Economics
Volume58
Early online date29 Aug 2019
DOIs
Publication statusPublished - Nov 2019

Keywords

  • Climate policies
  • Limit pricing
  • Monopoly
  • Non-renewable resource

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