Optimal environmental policy with network eects: Is lock-in in dirty technologies possible?


Network externalities could be present for many low or zero emission technologies. One obvious example is alternative fuel cars, whose use value depends on the network of service stations. 

The literature has only briefly looked at environmentally bene ficial technologies. Yet, the general literature on network effects is mixed on whether governments need to intervene in order to correct for network externalities.

In this paper we study implications of network effects on environmental policy in a discrete time dynamic game. Firms sell a durable good. One type of durable is causing pollution when being used, while the other type is "clean". Consumers' utility increase in the number of other users of the same type of durable, which gives rise to the network effect. 

We fi nd that the optimal tax depends on the size of the clean network. If starting from a situation in which the dirty network dominates, the optimal tax may exceed the marginal environmental damage, thereby charging consumers for more than just their own emissions. Applying a Pigovian tax may, on the contrary, fail to introduce a socially bene ficial clean network.

Published June 20, 2017 10:27 AM - Last modified July 26, 2017 1:46 PM