Allocation policy considering firm’s time-varying emission reduction in a cap-and-trade system

The global warming problem has attracted worldwide attention. Cap-and-trade has been increasingly used in many countries to reduce carbon emissions. However, some firms are concerned about the additional costs required for carbon reduction, and another important concern comes from grandfathering in permit allocation. This paper incorporates these costs and cap-and-trade concerns into a multi-period carbon reduction problem in a Stackelberg game. The findings show that neither cap-and-trade nor the firm’s carbon reduction choice will always benefit the environment. From the government’s perspective, we identify the optimal grandfathering scheme to maximize social welfare that incorporates economic and environmental concerns. We demonstrate that the socially optimal emissions level depends on the level of low-carbon technology and the environmental recovery cost.