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Optimal timing and scale of green technology with demand preferences for greener production

We study firms’ decisions concerning the timing of installing green technology in production and the optimal mix between brown and green technologies. Firms’ decisions are driven by uncertain demand, where consumers are environmentally sensitive and either reward products with more green technologies or penalize those that do not meet environmental targets. Capital allocation is also influenced by the relative costs of installing brown versus green technologies, as well as their efficiency in production. High regulatory targets for a green energy mix in production, such as those set within EU countries, help accelerate investment in green technologies. Firms aim to avoid higher penalties by investing earlier; however, this may result in a lower scale of green technology adoption. Factors such as higher volatility and growth levels of demand, less efficient green technologies, or high existing capacity may delay investment in the green transition. We explore the effect of an uncertain regime shift toward more environmentally sensitive consumers, demonstrating how this uncertainty impacts firms’ initial and subsequent choices between green and brown capital. We finally consider the social planner’s maximization problem which includes firm’s generated profits and the benefit for the society in the form of a consumer surplus as well as the negative externalities on the environment.