Welfare‐enhancing, time‐consistent environmental policies in fixed‐numbers and free‐entry oligopolies

Abstract This paper examines how the government's ability to commit, or not, to a specific emission tax level impacts environmental innovation and social welfare in fixed‐numbers and free‐entry oligopolies. We show that when the market is relatively concentrated, emission taxes are lower, while environmental innovation, profits and welfare are higher, under a time‐consistent policy than under a precommitment policy. Conversely, when the market concentration is relatively low, the rankings reverse. Furthermore, considering a free‐entry oligopoly, we show that there are still conditions under which the time‐consistent policy fosters higher environmental innovation and social welfare than a precommitment policy, even though the number of firms entering the market are higher under a time‐consistent emission tax. Therefore, contrary to prevailing beliefs, we show that the government's commitment to a policy may result in higher emissions and lower social welfare.