Valuation of the economic impact of the initial allocation of tradable emission permits in air pollution control. http://dx.doi.org/10.1061/(ASCE)EY.1943-7897.0000031

Abstract

One of the key concerns about applying emission permits systems in air pollution control is the initial allocation of entitlements. In this article, I introduce a model of the interaction of strategic firms and a permit allocating authority to assess social-welfare implications of initial allocation regimes of tradable emission permits. In particular, I formulate a three-period model for studying how the exercise of market power by oligopolistic firms affects the pollution control technology investments and, in this way, the valuation of different initial allocation proposals. The analysis shows that a proactive allocation of initial entitlements may improve social welfare with respect to a distribution made by an authority that ignores the interactions between the initial allocation of emission permits and the firms’ strategic response in pollution control technology investment. I illustrate the obtained results in the context of a sulfur dioxide emission permits system for the thermal electricity generation industry in Chile.