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Baseline-and-Credit Style Emission Trading Mechanisms: An Experimental Investigation of Economic Inefficiency

  • Neil J. Buckley
  • R. Andrew Muller
  • Stuart Mestelman

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 paper reports on a laboratory experiment designed to test the prediction in a laboratory environ- ment in which sub jects representing firms choose emission technologies and output capacities. A computerized environment has been created in which sub jects 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 aggregate output and emissions are in- efficiently high under a baseline-and-credit trading plan compared to a corresponding cap-and-trade plan.

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Paper provided by McMaster University in its series Department of Economics Working Papers with number 2005-04.

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Length: 38 pages
Date of creation: May 2005
Date of revision:
Handle: RePEc:mcm:deptwp:2005-04
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  1. Carolyn Fischer, 2003. "Combining rate-based and cap-and-trade emissions policies," Climate Policy, Taylor & Francis Journals, vol. 3(sup2), pages S89-S103, December.
  2. 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.
  3. Andrew Muller, R. & Mestelman, Stuart & Spraggon, John & Godby, Rob, 2002. "Can Double Auctions Control Monopoly and Monopsony Power in Emissions Trading Markets?," Journal of Environmental Economics and Management, Elsevier, vol. 44(1), pages 70-92, July.
  4. 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.
  5. Donald N. Dewees, 2000. "Emissions Trading: ERCs or Allowances," Working Papers dewees-00-01, University of Toronto, Department of Economics.
  6. 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.
  7. Neil J. Buckley & S. Mestelman & Andrew Muller, 2004. "Implications of Alternative Emission Trading Plans: Experimental Evidence," Department of Economics Working Papers 2004-07, McMaster University.
  8. 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.
  9. Neil J. Buckley, 2004. "Short-Run Implications of Cap-and-Trade versus Baseline-and-Credit Emission Trading Plans: Experimental Evidence," Department of Economics Working Papers 2004-05, McMaster University.
  10. R. Andrew Muller, 1999. "Emissions trading without a quantity constraint," Department of Economics Working Papers 1999-13, McMaster University.
  11. Fischer, Carolyn, 2001. "Rebating Environmental Policy Revenues: Output-Based Allocations and Tradable Performance Standards," Discussion Papers dp-01-22, Resources For the Future.
  12. Neil J. Buckley, 2004. "Short-Run Implications of Cap-and-Trade versus Baseline-and-Credit Emission Trading Plans: Experimental Evidence," McMaster Experimental Economics Laboratory Publications 2004-03, McMaster University.
  13. 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.
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