Multi-Sector Model of Tradable Emission Permits

This paper presents a multi-sector model of tradable emission permits, which includes oligopolistic and perfectly competitive industries. The firms in oligopolistic industries are assumed to exercise market power in the tradable permit market as well as in the product market. Specifically, we examine the effects of the initial permit allocation on the equilibrium outcomes, focusing on the interaction among these product and permit markets. It is shown that raising the number of initial permits allocated to one firm in an oligopolistic industry increases the output produced by that firm. Under certain conditions, raising a “clean” (less-polluting) firm’s share of the initial permits can lead to reductions in both the product and permit prices. We discuss criteria for the socially optimal allocation of initial permits, considering the trade-off between production inefficiency and consumer benefit.