Battle for Climate and Scarcity Rents: Beyond the Linear-Quadratic Case

Industria imports oil, produces final goods and wishes to mitigate global warming. Oilrabia exports oil and buys final goods from the other country. Industria uses the carbon tax to impose an import tariff on oil and steal some of Oilrabia's scarcity rent. Conversely, Oilrabia has monopoly power and sets the oil price to steal some of Industria's climate rent. We analyze the relative speeds of oil extraction and carbon accumulation under these strategic interactions for various production function specifications and compare these with the efficient and competitive outcomes. We prove that for the class of HARA production functions, the oil price is initially higher and subsequently lower in the open-loop Nash equilibrium than in the efficient outcome. The oil extraction rate is thus initially too low and in later stages too high. The HARA class includes linear, loglinear and semi-loglinear demand functions as special cases. For non-HARA production functions, Oilrabia may in the open-loop Nash equilibrium initially price oil lower than the efficient level, thus resulting in more oil extraction and climate damages. We also contrast the open-loop Nash and efficient outcomes numerically with the feedback Nash outcomes. We find that the optimal carbon tax path in the feedback Nash equilibrium is flatter than in the open-loop Nash equilibrium. It turns out that for certain demand functions using the carbon tax as an import tariff may hurt consumers' welfare as the resulting user cost of oil is so high that the fall in welfare wipes out the gain from higher tariff revenues.