Production and technology choice under emissions regulation: Centralized vs decentralized supply chains

To study how emissions regulations impact supply chain operations, we consider a supply chain where a supplier produces and sells raw material to a manufacturer, who then uses it to produce a final product to satisfy random market demand. Both firms are equipped with two production technologies, one of which is costlier, but generates fewer emissions than the other. Each firm’s emissions are capped by the amount of allowances it holds, and if the firm over-emits, it pays a penalty. We solve the optimal solutions of a centralized system, both jointly regulated and separately regulated, and a decentralized system. We find that the relationships between the emissions abatement cost, the emissions penalty, and the salvage value of the allowance largely determine the technology choice of the firms. For the centralized system, joint regulation results in a higher profit than separate regulation, but it may not result in a larger production quantity. For the decentralized system, under a more stringent regulation (fewer allowances), the firms may produce more while not using more of the green technology; and if the manufacturer has fewer allowances, the manufacturer and the whole chain may be better-off. The numerical study further illustrates that adding a green technology is always economically beneficial to the centralized supply chain, although it may hurt the manufacturer and the decentralized chain. In the scenarios where only either the supplier or the manufacturer is regulated, we show analytically that the centralized system produces more, uses more green technology, and generates more emissions than the decentralized one. More interestingly, the decentralized supply chain with the regulated supplier produces more, has a higher profit, and emits more than the supply chain with the regulated manufacturer when the emissions intensities of the production technologies are the same for the firms.