POLLUTION-CONTROL IN A COURNOT DUOPOLY VIA TAXES OR PERMITS

We consider an asymmetric Cournot duopoly with firms facing linear Leontief technologies. A pollutant is generated proportional to the quantity of output. The government may regulate the firms by imposing Pigouvian taxes or by issuing a number of tradeable permits. We characterize the optimal tax as well as the optimal permit policy as a function of a critical damage parameter. It turns out that in general neither the social optimum is enforceable, nor is one of the two policies always superior to the other. For a wide range of parameters, however, the permit policy leads to a higher welfare.