Incentives for environmental research and development: Consumer preferences, competitive pressure and emissions taxation

This paper examines the incentives of firms in exerting research and development (R&D) efforts to reduce the environmental cost of their production processes. Firms in almost every sector face mounting pressures from consumers, competitors and regulators to conduct environmental R&D. However, many are standing still due (mainly in part) to the trade-offs between benefits and costs, uncertainties and effectiveness of R&D activities. This paper presents a two-stage duopoly model that demonstrates how consumer demands, competitor actions and regulatory requirements can impact firms’ environmental R&D incentives. On the policy front, firms are regulated by a constant unit emissions cost under an emissions tax. On the demand side, in addition to deriving economic value from the product, consumers incur heterogeneous intrinsic costs (due to altruistic concerns) to consume environmentally inferior products, and exhibit “egoistic” preferences to consume their favorite brand. On the supply side, the efforts exerted by a firm generate a probability of R&D success with which the firm decreases the environmental cost of its production process, and the R&D cost exhibits diminishing returns to scale for R&D efforts. In this context, two firms compete on their R&D and pricing decisions in a two-stage game framework. Our results showcase a number of scenarios in which those external forces can induce firms to exert higher R&D efforts, some of which are counter-intuitive and contrary to commonly held assumptions and arguments about the role of consumer, competitive and regulatory pressures in environmental development.