Effects of Certainty on Decision Making under Uncertainty: using subsidies to reduce production of environmental harmful products

Abstract: The present thesis investigates the effects of an environmental policy, with the focus on producers’ decision making, which may be used as a means to decrease the production of environmentally harmful products. A subsidy system reimbursing a reduction in sales and/or production is with this aim experimentally investigated by simulating a market. In Study I, a price competition between pairs of participants was designed to test effects of a high and a low level of a subsidy, as compared to no subsidy. It was shown that the subsidy led to higher prices and reduced sales, and also inhibited the start of price wars. The results were dependent on the level of the subsidy, suggesting that participants used the subsidy and the opponent’s previous price as reference values to guide their behavior. Increased risk taking and/or risk aversion may also have influenced the participants’ behavior. In Study II, an experiment was performed to determine whether the subsidy decreased competition. The results showed that participants in competitive conditions did not behave collusive or cooperatively and that the effects f the subsidy were the same, yielding increased prices and reduced sales. Since EU prohibits coalitions or cartels it is important that the subsidy system reduced prices and sales while preserving cometitiveness. To test the hypothesis that a subsidy makes participants more risk taking, in Study III additional experiments were performed focusing on individual production decisions with certain (subsidy) or uncertain sales outcomes. The results showed that participants displayed inconsistent risk taking in that they preferred to diversify between a risky saes prospect and a guaranteed subsidy. Diversifying alternatives were thus rated as more preferable and more attractive, despite not maximizing expected values. The results are explained by that participants make trade?offs between certainty ? a guaranteed outcome, and a potential ? the highest possible outcome. Taken together, this thesis suggests that although there is a need for refinements and additional studies of the subsidy system, the results are promising in showing that introducing certainty in decision making under uncertainty may be used as part of a echanism to influence producers to reduce production of environmentally harmful products.