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OPTIMAL ALLOCATION OF TRADABLE EMISSION PERMITS UNDER UPSTREAM–DOWNSTREAM STRATEGIC INTERACTION

Giuseppe De Feo (), Joana Resende () and Maria-Eugenia Sanin ()
Additional contact information
Joana Resende: University of Porto, Department of Economics and Cef.up, Rua Dr. Roberto Frias, 4200–464, Porto, Portugal
Maria-Eugenia Sanin: University of Montpellier 1, UMR5474 LAMETA, and Ecole Polytechnique, Paris, France

International Game Theory Review (IGTR), 2012, vol. 14, issue 04, 1-23

Abstract: In this paper, we analyze environmental regulation based on tradable emission permits in the presence of strategic interaction in an output market with differentiated products. We characterize firms' equilibrium behavior in the permits and in the output market and we show that both firms adopt "rival's cost-rising strategies". Then, we study the problem of the regulator that aims at maximizing social welfare, proposing an efficient criterion to allocate permits between firms. We find that the optimal allocation criterion requires a perfect balance between the difference on firms' price-cost margins in the permits market and the difference on firms' mark ups in the output market. In light of the previous result, we use a simulation to obtain the optimal allocation of permits between firms as a function of output market characteristics, in particular as a function of goods substitutability.

Keywords: Tradable emission permits; strategic interaction; regulation; grandfathering (search for similar items in EconPapers)
JEL-codes: B4 C0 C6 C7 D5 D7 M2 (search for similar items in EconPapers)
Date: 2012
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DOI: 10.1142/S0219198912400038

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