"Green, Greener or Neutral ? Signaling Environmental Quality under Incomplete Information"

Abstract :
How can a firm signal the environmental quality of its product to consumers when its technology is unobservable ? This paper analyzes a monopoly market where the firm can be either green, using a costly non-polluting technology that generates positive externalities ; or neutral, relying on a standard technology. Consumers cannot directly observe the firm’s environmental performance and derive a warm glow benefit from purchasing green products. Under incomplete information, we derive a separating equilibrium where the green firm uses either one instrument (price) or two instruments (price and effort to improve the greenness of its product) to signal its environmental quality to consumers. Signaling can result in an improvement in total welfare by increasing the public good benefit of green consumption. This highlights the role of effort as a potential dual-purpose instrument : mitigating informational asymmetries and improving social surplus. Additionally, we explore how regulations such as green effort subsidies influence this equilibrium.