Firm Heterogeneity, Industry Dynamics and Climate Policy

Ara Jo, Christos Karydas

Research output: Working paper / PreprintWorking paper

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Abstract

We develop a dynamic general equilibrium model to quantify the interaction between climate policy, industry dynamics, and the elasticity of substitution between clean and dirty energy in the economy. The model incorporates empirical observations that firms differ substantially in their potential for energy substitution and that the economy is growing more capable of substituting clean for dirty energy over time as environmental regulation becomes more stringent. Our model highlights the effect of dynamic industry response on increasing the average elasticity of substitution in the economy due to the exit of least flexible firms in response to climate policy. The higher average elasticity of substitution increases the effectiveness of the policy at reducing emissions, resulting in a 35 percent decrease in the size of the carbon tax required to achieve carbon neutrality.
Original languageEnglish
Publication statusPublished - 15 Dec 2022

Publication series

NameBATH ECONOMICS RESEARCH PAPERS
PublisherDepartment of Economics - University of Bath
No.94/22
Volume2022

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