Abstract

We analyze how socially responsible consumers — those who care about climate change or another global externality — behave in a classical price-based market, derive properties of the resulting competitive equilibria, and study the effectiveness of different kinds of policies. Price taking is violated in that a vanishingly small consumer cares about her impact on the behavior of the rest of the market to a non-vanishing extent. That impact is endogenous to the situation and typically dampens her efforts to mitigate the externality. Even if all consumers put the same weight on the externality as the social planner, any equilibrium features overconsumption, and multiple equilibria can arise. To motivate socially responsible consumers to lower the externality, a unit tax is superior to a cap-and-trade-system in a closed economy, but there are policies that are even better than a tax. Furthermore, under trade with a large or very polluting partner, a cap is better than a tax. When there are two products that are perfect substitutes in consumption but generate different externalities, there is always an equilibrium in which the products have the same price and consumers are indifferent between them. Under conditions we identify, this selfish equilibrium is the unique equilibrium. In a selfish equilibrium, a cap and a unit tax on the dirty good can achieve the same outcomes. In non-selfish equilibria, a proportional subsidy on the cleaner product dominates both a unit tax and a cap.