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

  • Jinhua Zhao

A major concern with tradable emission permits (TEPs) is that stochastic permit prices may reduce firm incentive to invest in abatement capital or technologies relative to other policies such as a fixed emissions charge. However, under efficient permit trading, the price uncertainty is caused by abatement cost uncertainties which affect investment under both permit and charge policies. The authors develop a rational expectations general equilibrium model of permit trading to show how cost uncertainty affects investment. Differences between the two policies can be decomposed into a general equilibrium effect and a price-versus-quantity effect. Except for the curvature of the payoff functions, uncertainties reduce both effects so that tradable permits in fact help maintain firms' investment incentive under uncertainty.

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Paper provided by Center for Agricultural and Rural Development (CARD) at Iowa State University in its series Center for Agricultural and Rural Development (CARD) Publications with number 00-wp252.

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Date of creation: Aug 2000
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Handle: RePEc:ias:cpaper:00-wp252
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