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Impact of subsidy policies on green products with consideration of consumer behaviors: Subsidy for firms or consumers?

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Abstract

The subsidy policies have been being implemented as one of the instruments to leverage the uptake level of green products or technologies. However, the fact shows that the occupation level of such products or technologies is still far below expectations. In this study, we investigate two subsidy policies and their impacts on a market that comprises two vertically differentiated products: green and less green products. We consider two subsidy policies, namely, subsidy for firm and subsidy for consumer policies. Under the subsidy for firm policy, a regulator subsidizes the firm who produces greener products while under subsidy for consumer policy, the regulator subsidizes the consumers who buy greener products. We set the scope on consumers who exhibit the same characteristics such as preferences and green awareness level. We incorporate the reference-dependent preferences theory to derive consumers’ decisions on buying the green or less green products under the influence of each subsidy. Given our specific framework, the counter-intuitive theoretical result shows that subsidy for firm policy is capable to induce a higher level of the adoption of green products than subsidy for consumer policy.

Introduction

The urgency of dealing with the environmental issues has captured the world's attention to hasten its pace in changing human's consumption behaviors towards more sustainable ways. For example, several European countries have made announcement to ban vehicles running on fossil fuel by 2030-2050 or so (Eisenstein, 2017), and a range of various electric vehicles (EV) have been ubiquitous, particularly in some countries such as China, Japan, United States and several European countries (Miao et al., 2016; Miao, Xu, Zhang, Jiang, 2014). Battery-electric and fuel cell vehicles are viewed as two alternatives of fossil fuel vehicles to reduce the emission of greenhouse gas (Chelly, Nouira, Frein, and Hadj-Alouane, 2018; Shi, Wang, Yang, and Sun, 2016; Zapata and Nieuwenhuis, 2010). The popularity of electric vehicles has increased significantly in the past decade. In 2015, there were approximately 1.26 million electric cars worldwide (Electric Vehicles Initiative, 2016). Undoubtedly, the catalyst that enables this rapid uptake level is the substantive regulation including subsidy policies enacted in many incumbent countries such as the United States (Vergis et al., 2014). The EV deployment has so far been remarkable but the occupation level is still considerably low when compared to the total cars on the road worldwide (Electric Vehicles Initiative, 2016). The similar case is possibly encountered for other green products. In addition to the regulations of fossil fuel vehicles, government subsidies to green products consumption and consumers behaviors toward green products may play key factors to push for the uptake level of green products consumption. Consider the following scenario:

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    You would like to replace your car by a relatively expensive EV or a regular fossil fuel vehicle. You remember the government may provide subsidy incentives to either consumers or manufacturers to encourage the consumption of green products. The EV no doubt is with a higher environmentally quality, but with a higher price. In this situation, is your choice of new vehicles independent of subsidy gain of purchasing an EV or the phycological loss of not receiving subsidy of purchasing a regular fossil fuel vehicle? If instead you bought a regular fossil fuel vehicle with a lower price and lower environmentally quality, how would you feel about the savings? Do you feel the same intensity about an increase versus a decrease in the price you pay or the environmental quality you experience even if the increase and decrease are at the same magnitude?

This paper is to investigate subsidy policies that possibly enable higher uptake level of green products with addition of important factors related to consumers’ behavior which might have substantial effects on the uptake level of green products although some studies adopted the maximization of social welfare as the model objectives (Bansal and Gangopadhyay, 2003; Hong and Ke, 2011; Hong, Lee, and Chang, 2014). The social welfare including the profits obtained in less green and green firms might attenuate the effect of policy instruments on the encouragement of the uptake level of green products. Speaking of the subsidy policies, the federal government of the United States adopts the subsidy for consumer policy in the form of tax rebate (Internal Revenue Service, 2009 and 2016). The credit ranged from US$ 2,500 to US$ 7,500 depending on the capacity of vehicle's battery (Internal Revenue Service, 2016). The U.S. government asserted one million electric vehicles target on the road by 2015. The Plug-In Electric Vehicle (PEV) sales did grow to 118,773 in 2014 and it was approximately seven times higher than the PEV sales in 2011 (Electric Drive Transportation Association, 2016). As of the end of 2015, total sales of PEV cars in the U.S. amounted to 400,000 units (Shepardson & Woodall, 2016). Although the number was still far from one million electric vehicles targeted by the government, the U.S., by far, is still on top of the list of countries with high adoption level of electric vehicle (Electric Vehicles Initiative, 2016). Basically, consumers who purchase certain vehicles (mainly plug-in hybrid EV and battery EV) eligible for tax credits can have their tax liabilities reduced for the related year (Skerlos and Winebrake, 2010; Yang et al., 2016). While in China, instead of directly allocating subsidies to consumers, the subsidy (subsidy for firm) goes to the automaker companies who manufacture green products (Masiero et al., 2016). Table 1 summarizes the policies of subsidy for consumer and subsidy for firm. Recent data show that the growth of China's EV market share outpaces the United States in recent years (Electric Vehicles Initiative, 2016). At a glance, the two subsidies seem no different; however, they may not actually be exactly same. Consumers in the United States may have to wait for the benefit of the subsidy until their tax liabilities ready, and it probably takes more than a year in some cases. Zhou (2011) analytically and Holt and Laury (2002) empirically show that consumers exhibit loss aversion, which is a major driving factor comparing a product relatively to another one. To avoid the distraction from reading the paper, we leave the detailed explanation and justification of consumers’ behaviors in the Supplemental materials for readers. Consequently, consumers tend to segregate the gain of subsidies from the loss (the extra cost consumers pay for green products). On the other case, even when the subsidy is available at the point of sales, the regulator may not be sure that consumers treat gain and loss in a less painful way.

To date, there have been several studies examining subsidies designated for green firms or green consumers. Bansal and Gangopadhyay (2003) was the pioneer study to investigate various policy instruments of tax and subsidy to induce firms choosing greener technologies. Huang et al. (2013) investigated the subsidy for consumer policy to increase sales of electric automobiles and concluded that the subsidy incentive is more effective when consumers possess strong bargain power. Peng (2013) also studied the subsidy for consumer policy to stimulate the adoption of green products in a duopoly market. Krass et al. (2013) examined environmental taxes, fixed cost subsidies, and consumer discounts as instruments used by a regulator to maximize the social welfare in a monopolist market. Hong, Chen, and Yu (2016) examined the government subsidy to recycling flows in a reverse supply chain. Joo, Seo, and Min, (2018) empirically confirmed that government intervention benefits firms’ environmental and technological innovation capabilities. Other analyses on the various instruments adopted by a regulator to increase the uptake level of green products or to reduce emission of products appear in (Janssens and Zaccour, 2014; Jones et al., 2013; Liu, Huang, and Yang, 2017; Luo et al., 2014; Nishikawa, 2015; Sheu and Chen, 2012; Yalabik and Fairchild, 2011; Yu, Han, and Hu, 2016). Specifically, several means have been implemented to increase the sales of EVs such as license plate control (Zhang, Bai, and Zhong, 2018), popularity of the charging infrastructure and standardization of EV technology (Li et al., 2016), activation plan of electric taxi in Seoul (Kim, Lee, and Kim, 2017), and public policies (Olson, 2018). A recent study by Raz and Ovchinnikov (2015) deals with the three policies, namely, subsidy for firm and subsidy for consumer, and possible joint mechanism between the two with consideration of externality factors. Their findings show that subsidy for consumers is preferable compared to other policies and it may explain why the subsidy for consumer policy becomes prevalent worldwide. Despite their insightful findings, to our best knowledge, no studies attempt to incorporate consumers’ behavior in the subsidy policies. We believe that consumers’ behavior is essential since it drives demands in a market. Therefore, our study incorporates consumers’ behavior in the analysis of subsidy policies’ impacts on the uptake level of green products. Our study tries to connect consumers’ perspective, subsidy policies, and the uptake level of green products to investigate possible answers to the question in the real-world why a recent survey shows that the growth of the EV market share under the subsidy for green firms is greater than under the subsidy for consumers in recent years.

In this paper, there are two purposes we attempt to accomplish. First, we evaluate what policy may work better to leverage the uptake level of green products. We consider two subsidy policies, namely subsidy for firm and subsidy for consumer with consideration of consumers’ behavior. The problem setting in this study is the presence of a subsidy in a market with two competing firms selling substitute products with vertically-differentiated environmental quality. One firm produces a product with a higher environmental quality than the other. Both firms are assumed to aim the same segment market and thus spark a competition on price. Under the subsidy for firm policy, the regulator subsidizes the firm who produces green products on the basis of unit product sold. On the other hand, under the subsidy for consumer policy, the regulator directly subsidizes consumers who buy greener products. We establish two models based on the Stackelberg game, in which the leader makes decision first and then the follower determines the decision sequentially, that corresponds to each subsidy policy. The major criterion of the leader and follower is the disclosure time of information. In each model, we set the regulator as a leader and two competing firms as followers. We solve the problem and compare both firms’ and a regulator's optimal behavior under each subsidy policy so that we are able to observe which policy works better in terms of leveraging the market share of green products. Second, we also attempt to examine what factors cause a subsidy policy to be effective or less effective in leveraging the share of green products in a market. To do so, we build a model that relates a subsidy and consumers’ utility to investigate the role of a subsidy in governing a market demand of green products. We specifically focus on behavior of how consumers make their choice between buying a green or a less green product based on their utility. We rely heavily the utility theory in our study on reference-dependent preferences theory, which was proposed by (Kőszegi and Rabin, 2006), to establish a systematic decision making process experienced by a consumer. The reference-dependent preferences theory that we adopt in our study has obtained much attention in the past decade since it is capable to elucidate consumers’ behavior that are inconsistent with the classical expected utility theory. Thus, it is worth to incorporate the idea of reference-dependent preferences into the problem.

The contribution of this paper lies in the theoretical investigation of two commonly adopted subsidy polices with the consideration of the behaviors of consumers to explain the recent observation of effectiveness of subsidy policies. Surprisingly, our theoretical result shows, at least for our specific framework, that subsidy for firm policy is capable to be better than subsidy for consumer policy in promoting green products. This condition is found while consumers are under loss aversion phenomena and their reference price is slightly less than the actual price of green products. Our findings also show that loss aversion in price dimension worsens the adoption level while loss aversion in quality dimension does the other way. Consumers’ green awareness under subsidy for firm policy seems to give a significant impact on the green products’ adoption level, especially when the subsidy amount is relatively substantial. The remainder of this paper is organized as follows. In Section 2, we present our theoretical model to figure out the answers for our research problems. Section 3 demonstrates numerical analysis and provides some important insights into the current industry practice, and Section 4 includes conclusions and possible future directions of our work.

Section snippets

Theoretical model

We focus on the analysis of subsidy policies to encourage the uptake level of green products in a market by considering consumers’ preferences. The market environment in our analysis consists of two competing firms selling two products with differentiated environmental qualities. Both products can substitute each other; therefore, each consumer is to choose only one between them. There are two subsidy policies considered in this paper. The first one is subsidy for firm (SF) policy and the other

Numerical analysis

In this section, we examine impacts of changes in behavior parameters on the uptake level of green products and also the price difference between green and less green products under each policy. We perform sensitivity analysis specifically on the following parameters: consumers’ degree of expectation to buy the green products q, coefficient (slope) of gain function on price dimension η1, loss aversion index on price dimension λ1, coefficient (slope) of gain function on quality dimension η2,

Conclusions

The EV occupation level is still relatively low compared to the consumption of fossil fuel vehicles even though several countries implement subsidy policies. This paper is to examine subsidy policies (subsidy for firms or consumers) with consideration of important factors related to consumers’ behaviors which have substantial effects on the uptake level of green products. We establish two Stackelberg games, in which the regulator as a leader maximizes the uptake level of green products and two

CRediT authorship contribution statement

I-Hsuan Hong: Conceptualization, Data curtion, Formal analysis, Investigation, Methodology, Software, Validation, Visualization, Writing – original draft, Writing – review & editing. Anthony S.F. Chiu: Conceptualization, Formal analysis, Funding acquisition, Investigation, Methodology, Project administration, Supervision, Writing – original draft, Writing – review & editing. Lukas Gandajaya: Conceptualization, Data curtion, Formal analysis, Investigation, Methodology, Software, Supervision,

Declaration of Competing Interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

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    The corresponding author holds a joint appointment with the Department of Mechanical Engineering, National Taiwan University.

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