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Short-Run Implications of Cap-and-Trade versus Baseline-and-Credit Emission Trading Plans: Experimental Evidence

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  • Neil J. Buckley
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    Abstract

    Two approaches to emissions trading are cap-and-trade, in which an aggregate cap on emissions is distributed in the form of allowance permits, and baseline-and-credit, in which firms earn emission reduction credits for emissions below their baselines. Theoretical considerations suggest the long-run equilibria of the two plans will differ if baselines are proportional to output, because a variable baseline is equivalent to an output subsidy. This is in opposition to the prediction that when output capacity is fixed, the short-run equilibria of the two plans will be identical. As a first step towards testing the long-run model, this paper reports on a laboratory experiment designed to test the shortrun prediction. A computerized environment has been created in which subjects representing firms choose emission technologies under fixed output capacity and participate in markets for emission rights and for output. Demand for output is simulated. All decisions are tracked through a double-entry bookkeeping system. Our evidence supports the theoretical prediction that the two trading mechanisms yield similar outcomes, however both exhibit significant deviation from the predicted equilibrium.

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    Bibliographic Info

    Paper provided by McMaster University in its series Department of Economics Working Papers with number 2004-05.

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    Length: 35 pages
    Date of creation: May 2004
    Date of revision:
    Handle: RePEc:mcm:deptwp:2004-05

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    1. Godby, Robert W. & Mestelman, Stuart & Muller, R. Andrew & Welland, J. Douglas, 1997. "Emissions Trading with Shares and Coupons when Control over Discharges Is Uncertain," Journal of Environmental Economics and Management, Elsevier, vol. 32(3), pages 359-381, March.
    2. Cramton, Peter & Kerr, Suzi, 2002. "Tradeable carbon permit auctions: How and why to auction not grandfather," Energy Policy, Elsevier, vol. 30(4), pages 333-345, March.
    3. Neil Buckley & R. Andrew Muller & Stuart Mestelman, 2003. "Long-Run Implications of Alternative Emission Trading Plans: An Experiment with Robot Traders," Department of Economics Working Papers 2003-04, McMaster University.
    4. Donald N. Dewees, 2000. "Emissions Trading: ERCs or Allowances," Working Papers dewees-00-01, University of Toronto, Department of Economics.
    5. Parry, Ian & Pizer, William & Fischer, Carolyn, 1998. "Instrument Choice for Environmental Protection When Technological Innovation is Endogenous," Discussion Papers dp-99-04, Resources For the Future.
    6. Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
    7. Fischer, Carolyn, 2001. "Rebating Environmental Policy Revenues: Output-Based Allocations and Tradable Performance Standards," Discussion Papers dp-01-22, Resources For the Future.
    8. Fischer, Carolyn, 2003. "Combining Rate-Based and Cap-and-Trade Emissions Policies," Discussion Papers dp-03-32, Resources For the Future.
    9. Cason, Timothy N, 1995. "An Experimental Investigation of the Seller Incentives in the EPA's Emission Trading Auction," American Economic Review, American Economic Association, vol. 85(4), pages 905-22, September.
    10. Ben-David, Shaul & Brookshire, David S. & Burness, Stuart & McKee, Michael & Schmidt, Christian, 1999. "Heterogeneity, Irreversible Production Choices, and Efficiency in Emission Permit Markets," Journal of Environmental Economics and Management, Elsevier, vol. 38(2), pages 176-194, September.
    11. Cason, Timothy N. & Plott, Charles R., 1996. "EPA's New Emissions Trading Mechanism: A Laboratory Evaluation," Journal of Environmental Economics and Management, Elsevier, vol. 30(2), pages 133-160, March.
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    Cited by:
    1. Neil J. Buckley & R. Andrew Muller & Stuart Mestelman, 2005. "Baseline-and-Credit Style Emission Trading Mechanisms: An Experimental Investigation of Economic Inefficiency," Department of Economics Working Papers 2005-04, McMaster University.
    2. NeilJ. Buckley & Stuart Mestelman & R.Andrew Muller, 2006. "Implications Of Alternative Emission Trading Plans: Experimental Evidence," Pacific Economic Review, Wiley Blackwell, vol. 11(2), pages 149-166, 06.
    3. Neil J. Buckley & R. Andrew Muller & Stuart Mestelman, 2005. "Baseline-and-Credit Emission Permit Trading: Experimental Evidence Under Variable Output Capacity," Department of Economics Working Papers 2005-03, McMaster University.
    4. Neil J. Buckley & R. Andrew Muller & Stuart Mestelman, 2004. "Cap-and-Trade versus Baseline-and-Credit Emission Trading Plans: Experimental Evidence Under Variable Output Capacity," McMaster Experimental Economics Laboratory Publications 2004-06, McMaster University.

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