Working Paper: NBER ID: w24481
Authors: Jose Miguel Abito; Christopher R. Knittel; Konstantinos Metaxoglou; Andr Trindade
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.
Keywords: externalities; market coordination; environmental regulation; investment in capacity; wholesale electricity market
JEL Codes: L25; L94; Q48; Q53; Q54
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Externality prices (D62) | Firms reallocating output from markets with high externality prices to markets with low externality prices (H23) |
| Investment decisions (G11) | Investment in cleaner capacity (E22) |
| Market structure (D49) | The role of an integrated product market in coordinating environmental regulations (L50) |
| Investment in cleaner capacity (E22) | Increases the marginal benefit of investment and improves long-term outcomes (E22) |
| Firm profit maximization strategies (L21) | Direct causal relationship influencing regulatory outcomes (G18) |