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Strategic Manipulation of Pollution Permit Markets: An Experimental Approach

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  • Jamie Brown-Kruse
  • Steven R Elliot
  • Rob Godby

Abstract

In this paper we employ experimantal economic methods to examine the effect of market structure on the use of marketable emmisions permits. In particular, we ask whether firms can strategically manipulate a product market using marketable emissions permits. Subjects participate in two markets, a permit market and a product market. They use permits to reduce the cost of production of the final goods that they sell in the product market. Four treatments are used to test the effects of initial permit allocation and market structure. The first two treatments explore "simple" manipulation. In this case firms are all price takers in the product market but must compete both in the permit and final product markets, thus opening the potential use of permits as a form of market predation. Results show that in a market with one dominant firm and a number of fringe firms, strategic manipulation occurs repeatedly in the laboratory as the dominant firm uses licenses in an inefficient manner in order to minimize its costs, increase its profits and exclude rivals in the product market. Further these finding indicate, that far from improving market efficiency and decreasing the cost to society of pollution control, implementation of tradable permit markets where there are firms in a position of market power may decrease efficiency.

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File URL: http://socserv.socsci.mcmaster.ca/econ/rsrch/papers/archive/95-10.pdf
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Bibliographic Info

Paper provided by McMaster University in its series Department of Economics Working Papers with number 1995-03.

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Length: 35 pages
Date of creation: Mar 1995
Date of revision:
Handle: RePEc:mcm:deptwp:1995-03

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  1. Hahn, Robert W., 1982. "Market Power and Transferable Property Rights," Working Papers, California Institute of Technology, Division of the Humanities and Social Sciences 402, California Institute of Technology, Division of the Humanities and Social Sciences.
  2. Krattenmaker, Thomas G & Salop, Steven C, 1986. "Competition and Cooperation in the Market for Exclusionary Rights," American Economic Review, American Economic Association, American Economic Association, vol. 76(2), pages 109-13, May.
  3. Randolph M. Lyon, 1982. "Auctions and Alternative Procedures for Allocating Pollution Rights," Land Economics, University of Wisconsin Press, vol. 58(1), pages 16-32.
  4. Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, Elsevier, vol. 5(3), pages 395-418, December.
  5. Salop, Steven C & Scheffman, David T, 1983. "Raising Rivals' Costs," American Economic Review, American Economic Association, American Economic Association, vol. 73(2), pages 267-71, May.
  6. 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.
  7. Glenn W. Harrison & Michael McKee, 1985. "Monopoly Behavior, Decentralized Regulation, and Contestable Markets: An Experimental Evaluation," RAND Journal of Economics, The RAND Corporation, vol. 16(1), pages 51-69, Spring.
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Cited by:
  1. Requate, Till, 2005. "Environmental Policy under Imperfect Competition : A Survey," Economics Working Papers, Christian-Albrechts-University of Kiel, Department of Economics 2005,12, Christian-Albrechts-University of Kiel, Department of Economics.
  2. Hans-Theo Normann & Roberto Ricciuti, 2009. "Laboratory Experiments For Economic Policy Making," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 23(3), pages 407-432, 07.
  3. Bodo Sturm & Joachim Weimann, 2006. "Experiments in Environmental Economics and Some Close Relatives," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 20(3), pages 419-457, 07.
  4. Hansen, Kristiana & Kaplan, Jonathan D. & Kroll, Stephan, 2008. "Valuing Options in Water Markets: A Laboratory Investigation," Working Papers, Colorado State University, Department of Agricultural and Resource Economics 108722, Colorado State University, Department of Agricultural and Resource Economics.
  5. Stuart Mestelman & Andrew Muller, 1997. "What Have We Learned From Emissions Trading Experiments?," McMaster Experimental Economics Laboratory Publications, McMaster University 1997-03, McMaster University.
  6. Cason, Timothy N. & Gangadharan, Lata & Duke, Charlotte, 2003. "Market power in tradable emission markets: a laboratory testbed for emission trading in Port Phillip Bay, Victoria," Ecological Economics, Elsevier, Elsevier, vol. 46(3), pages 469-491, October.
  7. R. Andrew Muller & Stuart Mestelman & John Spraggon & Rob Godby, 1999. "Can auctions control market power in emissions trading markets," Department of Economics Working Papers 1999-12, McMaster University.
  8. Stuart Mestelman, 2000. "Environmental Policy: Lessons from the Laboratory," McMaster Experimental Economics Laboratory Publications, McMaster University 2000-01, McMaster University.
  9. Tisdell, John G. & Grainger, Corinne, 2008. "An Experimental Economic Analysis of Carbon Trading Options for Australia," 2008 Conference, August 28-29, 2008, Nelson, New Zealand, New Zealand Agricultural and Resource Economics Society 96661, New Zealand Agricultural and Resource Economics Society.
  10. Bodo Sturm, 2008. "Market Power in Emissions Trading Markets Ruled by a Multiple Unit Double Auction: Further Experimental Evidence," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 40(4), pages 467-487, August.
  11. Beat Hintermann, 2011. "Market Power, Permit Allocation and Efficiency in Emission Permit Markets," Environmental & Resource Economics, European Association of Environmental and Resource Economists, European Association of Environmental and Resource Economists, vol. 49(3), pages 327-349, July.
  12. Nguyen, N.P. & Shortle, J.S. & Reed, P.M. & Nguyen, T.T., 2013. "Water quality trading with asymmetric information, uncertainty and transaction costs: A stochastic agent-based simulation," Resource and Energy Economics, Elsevier, Elsevier, vol. 35(1), pages 60-90.

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