We consider a two-country model of price competition, with one polluting firm in each country and differentiated products. Assuming away, to simplify, abatement efforts and input substitution, we compare the impact on output, leakages, and trade volumes of a carbon tax versus an emission standard policy, unilaterally enacted by the home country. Under the tax the two firms set their prices simultaneously, in a Bertrand game. Under the standard the home firm’s price is conditioned on the price of the foreign firm, so as to abide the emission constraint. As a result, the tax leads to higher leakages and global emissions than the standard. The standard also implies a better trade balance for the home country than the tax.
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We would like to thank four anonymous referees for helpful comments. We are grateful to Carolyn Fischer, Emmanuel Petrakis, and Eftichios S. Sartzetakis for their suggestions and discussion. We would also like to thank seminar participants to the EAERE 2015 Conference, to the 2016 Oligo Workshop, and to the ASSET 2016 Conference. The usual disclaimer applies.
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