Edited by Jeroen C.J.M. van den Bergh
Chapter 18: Tradable Permits in Economist Theory
18 Tradable permits in economic theory Paul Koutstaal 1. Introduction Since tradable emission permits first appeared in economic theory in 1968 in a book by J.H. Dales, Pollution, Property and Prices, a large number of articles and books have been published on tradable permits. Moreover, tradable permits have been applied in practice, mainly in the US (see Chapter 19 in this volume by Tietenberg for an overview of the experiences with tradable permits). In this chapter some of the developments in the theory of tradable permits are outlined (for a more detailed overview of the issues addressed here the reader is referred to Tietenberg, 1985, and Klaassen, 1996). In the next section the rather restrictive assumption of perfect competition on permit and product markets is relaxed and it is investigated how this will influence the performance of tradable permits. Theoretical explanations for the lack of trade which has occurred in some of the tradable permit schemes that have been put into practice is the subject of Section 3. In Section 4 the consequences of non-compliance are studied. Last, both theoretical and experimental investigations into different types of auctions are discussed. 2. Tradable permits under perfect and imperfect competition Market power and cost-price manipulation With perfect competition in product and permit markets, tradable pollution rights are a cost-effective means for reducing pollution. Assume an (autonomous determined) emission reduction target E and let there be N polluting firms. Let qi be the quantity of a commodity produced by firm i for a...
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