Strategic Choice of Market Instrument

Abstract

This paper proposes a model where both regulator and industry behave strategically to endogenously choose the optimal market instrument. The regulator payoff function includes political gains from investment in abatement and improvement in the provision of the environmental good in addition to the efficient choice of the instrument level. Whereas the industry's objective is to minimize abatement costs. Under plausible conditions, the model suggests that quantity instrument is favorable to the regulator. Also, industry with high cost of abatement has a better incentive to invest in clean technology. Regulator gains from increasing the provision of environmental good and from industry investing in abatement.