OPTIMAL ENVIRONMENTAL TAXES: EFFECTS OF POLLUTION DECAY AND CONSUMER AWARENESS

Abstract. The effects of nonlinear decay and consumer preferences are analyzed in a setting where optimal extrac-tion of nonrenewable resources is combined with stock ex-ternalities. The control is exercised via a corrective tax and the time horizon is divided into two periods: an initial phase with extraction and a terminal phase without extraction. The time horizon with extraction is determined endogenously. The model does not assume separability of the objective function. The purpose here is to demonstrate that relatively simple de-viations from the standard assumptions, such as linear decay and no consumer awareness, may have large effects. Sensitiv-ity analyses indicate large differences in the optimal extraction period, the total level of extraction and cumulative emissions depending on the form of the decay function and the presence of consumers ’ awareness for the environment. Key Words: Global warming, fossil fuel extraction, dynamic optimization