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Strategic Manipulation of Pollution Permit Markets: An Experimental Approach

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

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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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. Krattenmaker, Thomas G & Salop, Steven C, 1986. "Competition and Cooperation in the Market for Exclusionary Rights," American Economic Review, American Economic Association, vol. 76(2), pages 109-13, May.
  2. Montgomery, W. David, 1972. "Markets in licenses and efficient pollution control programs," Journal of Economic Theory, Elsevier, vol. 5(3), pages 395-418, December.
  3. Hahn, Robert W, 1984. "Market Power and Transferable Property Rights," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 753-65, November.
  4. Salop, Steven C & Scheffman, David T, 1983. "Raising Rivals' Costs," American Economic Review, American Economic Association, vol. 73(2), pages 267-71, May.
  5. 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.
  6. Randolph M. Lyon, 1982. "Auctions and Alternative Procedures for Allocating Pollution Rights," Land Economics, University of Wisconsin Press, vol. 58(1), pages 16-32.
  7. 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.
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