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Optimal Allocation Of Tradable Emission Permits Under Upstream–Downstream Strategic Interaction

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Author Info

  • GIUSEPPE DE FEO

    ()
    (University of Strathclyde, Department of Economics, 103 Rottenrow, Glasgow G4 OGE, United Kingdom and Università degli Studi di Pavia, Italy)

  • JOANA RESENDE

    ()
    (University of Porto, Department of Economics and Cef.up, Rua Dr. Roberto Frias, 4200–464, Porto, Portugal)

  • MARIA-EUGENIA SANIN

    ()
    (University of Montpellier 1, UMR5474 LAMETA, and Ecole Polytechnique, Paris, France)

Abstract

In this paper, we analyze environmental regulation based on tradable emission permits in the presence of strategic interaction in an output market with differentiated products. We characterize firms' equilibrium behavior in the permits and in the output market and we show that both firms adopt "rival's cost-rising strategies". Then, we study the problem of the regulator that aims at maximizing social welfare, proposing an efficient criterion to allocate permits between firms. We find that the optimal allocation criterion requires a perfect balance between the difference on firms' price-cost margins in the permits market and the difference on firms' mark ups in the output market. In light of the previous result, we use a simulation to obtain the optimal allocation of permits between firms as a function of output market characteristics, in particular as a function of goods substitutability.

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Bibliographic Info

Article provided by World Scientific Publishing Co. Pte. Ltd. in its journal International Game Theory Review.

Volume (Year): 14 (2012)
Issue (Month): 04 ()
Pages: 1240003-1-1240003-23

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Handle: RePEc:wsi:igtrxx:v:14:y:2012:i:04:p:1240003-1-1240003-23

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Related research

Keywords: Tradable emission permits; strategic interaction; regulation; grandfathering;

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  1. Hahn, Robert W., 1982. "Market Power and Transferable Property Rights," Working Papers 402, California Institute of Technology, Division of the Humanities and Social Sciences.
  2. Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
  3. Nils-Henrik Mørch von der Fehr, 1993. "Tradable emission rights and strategic interaction," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 3(2), pages 129-151, April.
  4. Misiolek, Walter S. & Elder, Harold W., 1989. "Exclusionary manipulation of markets for pollution rights," Journal of Environmental Economics and Management, Elsevier, vol. 16(2), pages 156-166, March.
  5. Salinger, Michael A, 1988. "Vertical Mergers and Market Foreclosure," The Quarterly Journal of Economics, MIT Press, vol. 103(2), pages 345-56, May.
  6. Ordover, Janusz A & Saloner, Garth & Salop, Steven C, 1990. "Equilibrium Vertical Foreclosure," American Economic Review, American Economic Association, vol. 80(1), pages 127-42, March.
  7. Boemare, Catherine & Quirion, Philippe, 2002. "Implementing greenhouse gas trading in Europe: lessons from economic literature and international experiences," Ecological Economics, Elsevier, vol. 43(2-3), pages 213-230, December.
  8. Yihsu Chen & Benjamin Hobbs & Sven Leyffer & Todd Munson, 2006. "Leader-Follower Equilibria for Electric Power and NO x Allowances Markets," Computational Management Science, Springer, vol. 3(4), pages 307-330, September.
  9. Pedro Linares & Francisco Javier Santos & Mariano Ventosa & Luis Lapiedra, 2006. "Impacts of the European Emissions Trading Scheme Directive and Permit Assignment Methods on the Spanish Electricity Sector," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 79-98.
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