The effects of taxes and subsidies on environmental qualities in a differentiated duopoly

In a horizontally differentiated duopoly, a green attribute (environmental quality) can be added to the products. Average green quality generates a positive externality entering the Government’s objective function (and possibly consumers’ utility). A tax on the “dirtiest” product decreases its environmental quality but it increases that of the cleaner rival enough to imply an average quality increase, achieving environmental protection. The same holds for a subsidy to production targeted to the cleanest producer. A generic quality-related subsidy also increases the positive externality, increases profits of the greenest and lowers those of the dirtiest producer. Education campaigns by the Government also increase average green quality.