Optimal joint decisions of production and emission reduction considering firms’ risk aversion and carbon tax rate

Carbon tax represents governments’ approach to steering the economy towards a greener future. Our research question focuses on the impact of carbon tax policy on a firm’s production decision and revenue and on total social welfare. In particular, we assume that a firm’s decision is subject to its behavioural considerations or, in other words, its risk attitude. We model a government plan to charge a carbon tax, and a risk-averse (or risk-neutral) firm needs to plan its production and estimate its profit if the carbon tax policy is implemented. We show that it is possible for a risk-averse firm’s optimal profit, in some cases, to be higher than that of a risk-neutral firm when facing a carbon tax. This implies that the risk-averse attitude is not necessarily harmful to the firm’s profit. For operations management scholars, our model highlights the importance of integrating firms’ behavioural responses into the carbon tax price. Our model suggests that for governments to implement carbon tax policy effectively, they should make carbon prices vary under certain conditions and not worry about price variation antagonising firms at large.