Information Disclosure Policies: When Do They Bring Environmental Improvements?

Abstract

There has been a growing interest among policy makers on the use of information disclosure policies for pollution control. This paper theoretically assesses the consequences of information disclosure policies and identifies the conditions under which such policies are likely to bring environmental improvements. Based on a dynamic game framework, the paper shows that both eco-labeling and more general full information disclosure policies may not always result in pollution reduction. Full information disclosure policies are likely to be effective if the product is not heavily polluting and if the minimum quality standard is set quite low. The paper also identifies the conditions under which all consumers are strictly better off with information disclosure policies.

Appendix

Proof of Lemma 1

Consider how firm L’s profit changes when the threshold $\widetilde{e}$ is incrementally increased from $\underline{e}$. By assumption, firm H applies for the eco-label when $\widetilde{e}$ is set sufficiently low and therefore $e_{{\text{H}}} = \widetilde{e}$. I compare firm L’s profit when it chooses to apply for the label and when it chooses not to apply.

If L chooses to apply, the profit is given by (substituting $e_{{\text{L}}} = \widetilde{e}$ into Eq. 5′),

$$ \pi _{{\text{L}}} = \frac{{\overline{\theta } ^{2} }} {9}\widetilde{e} - c{\left( {\widetilde{e}} \right)} $$

If the threshold is increased, the change in the profit is characterized by

$$\begin{array}{*{20}c} {\frac{{\partial \pi _{{\text{L}}} }}{{\partial \widetilde{e}}} = \frac{{\overline{\theta } ^{2} }}{9} - c\prime {\left( {\widetilde{e}} \right)}} \\ {\frac{{\partial ^{2} \pi _{{\text{L}}} }}{{\partial \widetilde{e}^{2} }} = - c\prime \prime {\left( {\widetilde{e}} \right)} < 0.} \\ \end{array} $$

The first derivative of the profit function is positive as long as the slope of the cost function is not too steep. As a special case, firm L may never choose to apply for the label if the minimum quality standard is set high so that the slope of the cost function at the minimum standard is sufficiently steep. Otherwise, firm L has an incentive to apply for the label and the profit increases initially as the threshold is increased from the minimum required level $\underline{e}$. However, with a convex cost function, the profit ultimately decreases at an increasing rate as the second derivative shows.

If L chooses not to apply for the label, from Eq. 5′,

$$\begin{array}{*{20}c} {\frac{{\partial \pi _{{\text{L}}} }}{{\partial \widetilde{e}}} = \frac{{ - 2\widetilde{e}\underline{e} ^{2} \overline{\theta } ^{2} }}{{{\left( {4\widetilde{e} - \underline{e} } \right)}^{3} }} < 0} \\ {\frac{{\partial ^{2} \pi _{{\text{L}}} }}{{\partial \widetilde{e}^{2} }} = \frac{{{\left( {16\widetilde{e} + 2\underline{e} } \right)}\underline{e} ^{2} \overline{\theta } ^{2} }}{{{\left( {4\widetilde{e} - \underline{e} } \right)}^{4} }} > 0} \\ \end{array} $$

Thus, the profit decreases but at a decreasing rate. Therefore, if $\widetilde{e}$ is sufficiently high, L’s profit without applying for the eco-label becomes larger than that with the label. Therefore, there is a quality level such that firm L applies for the label if the threshold is set below that quality level and does not apply if the threshold is set above that quality level.

If firm L switches from applying for the label to not applying for the label, firm H’s profit increases and therefore firm H continues to apply for the label even if firm L chooses not to apply. This can be seen as follows. Suppose when the threshold is set at $\underline{e}$, firm L is indifferent between applying and not applying for the label. Firm H’s profit when firm L applies for the label is given by

$$ \pi _{{\text{H}}} = \frac{{\overline{\theta } ^{2} }} {9}\widetilde{e} - c{\left( {\widetilde{e}} \right)}. $$

and the profit when firm L does not apply is given by Eq. 9. The difference between Eq. 9 and this equation is given by

$$ {\left[ {\frac{{\widetilde{e} + {\left( {\widetilde{e} - \underline{e} } \right)}}} {{3\widetilde{e} + {\left( {\widetilde{e} - \underline{e} } \right)}}}} \right]}^{2} \overline{\theta } ^{2} \widetilde{e} - \frac{{\overline{\theta } ^{2} }} {9}\widetilde{e}, $$

and this is positive since ${\left[ {\frac{{\widetilde{e} + {\left( {\widetilde{e} - \underline{e} } \right)}}} {{3\widetilde{e} + {\left( {\widetilde{e} - \underline{e} } \right)}}}} \right]}^{2} > \frac{1} {9}$. Thus, firm H continues to apply for the eco-label even if firm L switches from applying to not applying for the label. Therefore, there is a quality level such that both firms apply for the label if the threshold is set below that quality level and only firm H applies if the threshold is set above that quality level.

To see that firm H does not apply for the label if the threshold is set sufficiently high, note that firm H’s profit given by Eq. 9 is also expressed as

$$ \pi _{{\text{H}}} = \frac{{\overline{\theta } ^{2} }} {4}\widetilde{e} - \frac{{\widetilde{e}\underline{e} {\left( {2\widetilde{e} - \frac{3} {4}\underline{e} } \right)}\overline{\theta } ^{2} }} {{{\left( {4\widetilde{e} - \underline{e} } \right)}^{2} }} - c{\left( {\widetilde{e}} \right)}. $$

The first term is positive but the second and the third terms are negative. Since cost function is convex, the third term dominates the first term as $\widetilde{e}$ increases. Thus, if $\widetilde{e}$ is sufficiently high, the profit becomes lower than that without applying for the label and therefore firm H chooses not to apply for the label. ▪