EKC-type transitions and environmental policy under pollutant uncertainty and cost irreversibility

Previous studies have suggested that some pollutant levels first increases due to the economic growth and then start decreasing, the pattern being called the “environmental Kuznets curve” (EKC). We examine EKC-type transitions of pollutant levels not with respect to economic growth but more generally in time. Assuming that each policy maker optimally executes the two switching options of regulation and unregulation for pollution, the switching dynamics of environmental policy can be described by an alternating renewal process. It is shown that the double Laplace transform of transition density of a pollutant level can be obtained by a novel application of renewal theory. The expected level of overall pollutants is then calculated numerically and found to exhibit either a Λ‐shaped or an N-shaped pattern in time. Our results present a simple explanation for the EKC-type transitions of pollutant levels within a real options framework.