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Irreversible Abatement Investment Under Cost Uncertainties: Tradable Emission Permits and Emissions Charges

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  • Zhao, Jinhua

Abstract

A major concern with tradable emission permits is that stochastic permit prices may reduce a firm's incentive to invest in abatement capital or technologies relative to other policies such as a fixed emissions charge. However, under efficient permit trading, the permit price uncertainty is caused by abatement cost uncertainties which affect investment under both permit and charge policies. We develop a rational expectations general equilibrium model of permit trading and irreversible abatement investment to show how cost uncertainties affect investment under permits. We compare the resulting investment incentive with that under charges. After controlling for the assumption that random shocks affect the abatement cost linearly, we find that firms' investment incentive decreases in cost uncertainties, but more so under emissions charges than under permits. Therefore, tradable permits in fact may help maintain firms' investment incentive under uncertainty.

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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 10223.

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Date of creation: 01 Jan 2003
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Publication status: Published in Journal of Public Economics 2003, vol. 87, pp. 2765-2789
Handle: RePEc:isu:genres:10223

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
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Web page: http://www.econ.iastate.edu
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