Working Paper: NBER ID: w13510
Authors: Erin T. Mansur
Abstract: In a market subject to environmental regulation, a firm's strategic behavior affects the production and emissions decisions of all firms. If firms are regulated by a Pigouvian tax, changing emissions will not affect the marginal cost of polluting. However, under a tradable permits system, the polluters' decisions affect the permit price. This paper shows that this feedback effect may increase a strategic firm's output. Relative to a tax, tradable permits improve welfare in a market with imperfect competition. As an application, I model strategic and competitive behavior of wholesalers in the Pennsylvania, New Jersey, and Maryland electricity market. Simulations suggest that exercising market power decreased local pollution by approximately nine percent, and therefore, substantially reduced the price of the region's pollution permits. Furthermore, I find that had regulators opted to use a tax instead of permits, the deadweight loss from imperfect competition would have been approximately seven percent greater.
Keywords: Environmental Regulation; Imperfect Competition; Tradable Permits; Emissions Taxes
JEL Codes: L13; L94; Q53
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strategic behavior (L21) | local emissions (Q52) |
| strategic behavior (L21) | price of pollution permits (Q58) |
| choice of regulatory instrument (tax vs. permits) (Q58) | deadweight loss (H21) |
| strategic behavior (L21) | emissions levels (Q52) |
| emissions levels (Q52) | price of pollution permits (Q58) |
| emissions levels (Q52) | welfare outcomes (I38) |