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Trade liberalization, optimal environmental policy in a vertical related market

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Working paper

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We analyze the optimal environmental policies and how trade liberalization affects environmental policies in the context of vertical structure that supports production of the downstream- bilateral traded good.

Consider a symmetric, vertically related structure model of downstream bilateral trade. In the final-good markets, there is a single, tradable good produced by two firms, each located in a different country, domestic () and foreign (). Each firm sells in both countries. In addition, imports to each country are subject to a tariff, T, for simplicity, that we assume exogenous and the same in both countries. In the intermediate-good markets, we frame our model around a decentralized vertical market structure that supports the downstream in their own country.

In each country there is a government whose goal is to maximize national welfare by setting the value of pollution tax and  ( and ) if the downstream (upstream) firm is a polluted industry.

The model involves three stages of decision. In the first stage, the home and the foreign governments simultaneously commit to their environmental instruments. Next, the second stage the upstream firms choose input-price for their home market. In the third stage, the market for the final good involves a Cournot-Nash equilibrium.

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Extension:

1.      variable return to scale in production function, intermediate-good export, which can see the environmental policy difference between upstream and downstream

2.      n firms setting in upstream, which can see the effect of market structure change in upstream

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