# 15-136/VIII (2015-12-18; 2017-01-30)

Author(s)
Gerard van der Meijden, VU University Amsterdam, the Netherlands; Karolina Ryszka, VU University Amsterdam, the Netherlands; Cees Withagen, VU University Amsterdam, the Netherlands
Keywords:
limit pricing, non-renewable resource, monopoly, carbon tax
JEL codes:
Q31, Q37

We study fossil fuel extraction by a monopolist who faces demand from a climateaware and a climate-ignorant region. A renewable, perfect substitute for fossil energy is available at constant unit cost. The climate-aware region uses a carbon tax and a renewables subsidy as policy instruments. Due to heterogeneity in climate policies between regions, the fossil fuel price path possibly contains two limitpricing phases. Moreover, the shape of the price path depends on the presence of arbitrators on the market. With arbitrators, the fossil price is continuous. Without arbitrators, the price jumps upward when demand from the climate-aware region drops to zero. A tightening of climate policies results in lower initial resource use. The effect on medium-run extraction and on the duration of the fossil era depends on the presence of arbitrators on the market. We numerically investigate
the welfare effects of the policies of the climate-aware region. We find that the carbon tax lowers climate damage. The renewables subsidy, however, only lowers climate damage if there are arbitrators on the market.