Reducing the emissions gap through endogenous absorptive capacity and regulatory tax

This paper addresses the regulation of two firms when the process of production generates emissions and when a gap in reducing emission ratio exists. One of the two firms has a technological advance vis-à-vis the other such that it has a smaller emission ratio level. The less developed firm may benefit from this technological advance as it invests in its absorptive capacity. The analysis employs a three-stage duopoly game in which the regulator acts strategically in determining its tax on emissions. Finding that the investment in absorptive capacity increases with respect to the learning capacity of the less developed firm and when the technology gap between them is larger. Moreover, the regulator is more aggressive towards emissions when the marginal disutility of the damage is strong and/or the initial technological gap is smaller. © 2015, Springer-Verlag Berlin Heidelberg.