Optimal Policy Combinations of Abatement Subsidy and Pollution Tax in Vertical Oligopolies

This article investigates environmental regulations on eco-industry in vertical oligopolies, in which the upstream industry produces abatement goods reducing pollutants and the downstream industry produces consumption goods emitting pollutants. We devise the optimal combination of appropriate policy instruments and show that an optimal pollution tax should be used for the negative externality and output restrictions in final production, and an optimal abatement subsidy should incorporate the effect of upstream market restrictions on abatement activity. We also examine the welfare effect of the subsidy policy on the abatement technology in tax/subsidy combination.