Competing on Emissions Charges

Abstract

This research presents a game-theoretic model to analyse market equilibria in the presence of environmental policies at national and supranational levels. In a two-stage game, regulators maximise welfare over their jurisdiction by setting emission charges, whilst airlines compete through frequencies, fares, and fleet choice. Consequently, airlines decide whether to absorb the costs of the environmental charges, pass them on to consumers, replace part of their fleet with more efficient aircraft or redistribute the inefficient fleet to less regulated itineraries. The equilibria outcomes suggest the presence of several distorting forces that can undermine the effectiveness of environmental policies. To assess the robustness of our results, we apply the model to North American and Western European markets, under different regulatory setting, finding that a reduction in the emissions produced comes at the expense of the welfare and that the effectiveness of the policy is limited when regulators interact in their own interests.