In the absence of taxes, which technology would the firm choose? Suppose now that the government can impose a lump-sum tax τ that the firm has to pay if it uses the polluting technology. If it uses the clean technology, it does not have to pay any taxes. What is the lowest value of the tax such that the firm would prefer to use the clean technology rather than the polluting one?
Next, we want to understand some of the mechanisms that can shape the behaviour of negotiators at the COP meetings.1 For simplicity, consider two countries the US (U) and Fiji (F). Each country i ∈ {U, F} can decide whether to impose a positive tax on the emissions of its polluting firms (τi > 0) or to impose no tax (τi = 0).
Let’s consider first the effect that the taxes on CO2 would have on emissions and on
profitability. We can think of a representative firm that chooses whether to produce
using a polluting technology (q = P) or a clean technology (q = C). The polluting
technology generates profits of π(P) = 11 with certainty. The clean technology is new
and comes with a risk of lowering profits. In particular, with probability 3/4 the profits
with the clean technology will be π(C) = 12 but with probability ¼ the profits with that
technology will be π(C) = 4. Assume that when the firm is indifferent between the two
technologies, it chooses the clean technology.
- In the absence of taxes, which technology would the firm choose?
- Suppose now that the government can impose a lump-sum tax τ that the firm has to pay if it uses the polluting technology. If it uses the clean technology, it does not have to pay any taxes. What is the lowest value of the tax such that the firm would prefer to use the clean technology rather than the polluting one?
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