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Cap and Trade under Transactions Costs

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  • Singh, Rajesh
  • Weninger, Quinn

Abstract

We study equilibrium production and emission in a model where firms jointly produce a valued good and an environmental bad, pollution. Firms are ex ante identical but receive random productivity shocks. A regulator imposes a cap-and-trade policy to control pollution emissions. Trade in emission permits entails transactions costs which follow two specifications: constant per unit trading costs or fixed trading costs. Under proportional costs, the equilibrium outcome is independent of buyers' and sellers' costs and depends only on the total, buyers' plus sellers, per unit trading cost. Under fixed costs, both buyers' and sellers' costs matter. Under proportional costs trade always occurs, either fully or partially, as long as the total trading costs are below the market surplus obtained from the traded permit. With fixed costs, trade is either partial or non-existent. The implication is that production is efficient for a range of proportional trading costs, but always inefficient under fixed costs. In either case, trade is impeded most, even with small costs, when the emission permit market is thin, i.e., when the mass of buyers and sellers is small. We derive a non-monotonic relationship between the aggregate emissions cap and an upper bound for trading costs that obstruct or preclude trade. Further, we find that output loss due to emissions-permit-constrained unutilized capacity increases with productivity variance under ad valorem costs, the result is the opposite under fixed costs.

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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 37453.

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Date of creation: 29 Mar 2014
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Handle: RePEc:isu:genres:37453

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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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Related research

Keywords: Cap-and-trade regulation; emissions permit trading; ad valorum and fixed transactions costs; capacity utilization.;

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  1. Stavins Robert N., 1995. "Transaction Costs and Tradeable Permits," Journal of Environmental Economics and Management, Elsevier, vol. 29(2), pages 133-148, September.
  2. Heindl, Peter, 2012. "Transaction costs and tradable permits: Empirical evidence from the EU emissions trading scheme," ZEW Discussion Papers 12-021, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  3. Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
  4. Singh, Rajesh & Weninger, Quinn, 2012. "Harvest Efficiency and Discards under Harvest Uncertainty and Trading Frictions," Staff General Research Papers 35039, Iowa State University, Department of Economics.
  5. Lata Gangadharan, 2000. "Transaction Costs in Pollution Markets: An Empirical Study," Land Economics, University of Wisconsin Press, vol. 76(4), pages 601-614.
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