Environmental Policy when Market Structure and Plant Locations Are Endogenous

A two-region, two-firm model is developed in which firms choose the number and the regional locations of their plants. Both firms pollute, and market structure is endogenous to environmental policy. There are increasing returns at the plant level, imperfect competition between the "home" and the "foreign" firm, and transport costs between the two markets. At critical levels of environmental policy variables, small policy changes cause large discrete jumps in a region′s pollution and welfare as a firm closes or opens a plant, or shifts production to/from a foreign branch plant. The implications for optimal environmental policy differ significantly from those suggested by traditional Pigouvian marginal analysis.