Standards and technology innovation with search

This paper examines optimal environmental regulation based on emission or performance standards in the presence of consumer search and firm innovation. With an exogenous market structure, we find that the emission and performance standards lead to the same equilibrium level of innovation, which decreases in the degree of competition in a Schumpeterian way, and these two policy tools are equivalent in terms of total welfare but not in distributional terms because they give rise to different levels of consumer and producer surplus. Here, low search costs can lead to price-increasing competition for concentrated industries and spillovers determine the time consistency of the standards. With an endogenous market structure, the two regulatory instruments lead to different levels of total welfare, they both yield excessive firm entry, and the magnitude of the inefficiency from excessive entry is relatively greater under the emission standard.