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Coordinating Separate Markets for Externalities

Jose Miguel Abito, Christopher Knittel (), Konstantinos Metaxoglou and Andre Trindade

No 24481, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show that inefficiencies from having separate markets to correct an environmental externality are significantly mitigated when firms participate in an integrated product market. Firms take into account the distribution of externality prices and reallocate output from markets with high prices to markets with low prices. Investment in cleaner and more efficient capacity serves as an additional mechanism to reallocate output, which increases the marginal benefit of investment, and consequently improves longer-term outcomes. Using data from an integrated wholesale electricity market, we estimate a dynamic structural model of production and investment to bound the loss from separate markets for carbon dioxide emissions, and quantify the extent to which optimal investment can compensate for the loss. Despite the lack of the “invisible hand” of a single emissions market, profit-maximizing firms can play a crucial role in coordinating otherwise uncoordinated environmental regulations.

JEL-codes: L2 L5 L94 Q48 Q53 Q54 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-com, nep-ene, nep-env and nep-reg
Date: 2018-04
Note: EEE IO
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