In this paper, we analyze the effect of foreign direct investment (FDI) on government’s optimal pollution tax in the presence of pollution and asymmetric efficiency between firms. And how foreign firm decide its foreign direct investment strategy under the particular pollution tax. We use a two-country setting (home and foreign) share game model. Each country has one firm, and two ﬁrms engage in Cournot competition.
We show that when two firms are efficiency asymmetric, if marginal cost of foreign is higher than home firm, home government will strategically raise its optimal pollution tax to prevent foreign firm from doing foreign direct investment under higher marginal pollution. On the contrary, if marginal cost of foreign is lower than home firm, home government will strategically raise its optimal pollution tax to shift the profit from foreign firm to home country under higher marginal pollution. At this time, foreign firm will monopoly the home market. When fixed cost of the foreign direct investment decrease, home government will strategically reduce its optimal pollution tax to keep both firms in the market.
After generalizing this model, we found that as the amount of firms in home country increasing, due to the decreasing marginal revenue of foreign firm, optimal pollution tax will star decrease and then return to increase. What we have found above are different to the related reference in the past.
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