Ulric B. and Evelyn L. Bray Social Sciences Seminar

Abstract: Attribute-based subsidies are commonly used to promote the diffusion of energy-efficient products in industries with significant market power. We first develop a theoretical framework for optimal policy design that incorporates endogenous product attributes, environmental externalities, and market power. We then estimate an equilibrium model of China's vehicle market using comprehensive data to evaluate the welfare impacts of different subsidy designs. Counterfactual simulations based on model estimates demonstrate that uniform subsidies are effective in promoting small and environmental-friendly vehicles but exacerbate the quantity distortion from market power for high-quality products. In contrast, attribute-based subsidies (such as those based on the driving range or battery capacity) generate a larger consumer surplus by mitigating market power and improving product quality. Capacity-based subsidies are the most effective in inducing attributes valued by consumers and mitigating market power, and result in the largest welfare gain at a moderate loss of environmental benefit. These findings highlight the importance of incorporating endogenous product-attributes and market power considerations in the design of attribute-based environmental regulations.

Joint work with Hyuk-soo Kwon and Shanjun Li.