Emissions Trading Model
In-Class Emissions Trading Model Exercise
In addition to providing a respite from lectures, the purpose of this exercise is to learn more about the practical process that underlies the path to equilibrium in a tradable permit market. We will base our market set-up on a model developed by a professor at the University of Illinois,1but will alter the way her exercise is conducted in order to explore the role of information in achieving a cost-effective outcome. The remainder of this document is organized into two sections. The first describes the set-up of the exercise and rules for how permit trading will be conducted. These rules are intended to reduce transaction costs and give the market the best possible chance of succeeding (i.e., achieving cost-effectiveness). The second section of this document contains three questions about the exercise that you will need to answer in a short written assignment.
I. Emissions Trading Model
(1) Firms
Our tradable permit market will consist of eight firms. We describe firms only by their marginal benefits of making another unit of emissions. These MBE functions are given by the following equations, and are portrayed in graphs on the following three pages. Firms differ both by amount of emissions they would choose to create in the absence of regulation, and in the marginal cost of cleaning up a unit of emissions. Each team (comprised of 2-3 students) will be assigned to represent one of the firms Mimeo, Department of Agricultural and Consumer Economics. University of Illinois at Urbana- Champaign.
(2) No-Trading Status Quo
We begin with a world in which each firm is assigned an equal amount of emissions (E=1650) that they may produce free-of-charge. You should calculate your firm’s marginal cost of abatement at that level of emissions, along with that of other firms in the market. Is your marginal cost high or low? Do you expect to be a buyer or a seller of permits? You should think about who your first trading partner might be.
(3) Trading
In order to facilitate trading, we will require all trades to take place in 100 unit increments. The “trading representative” from each firm will need to bilaterally negotiate a price with the “trading department” of another firm (you will want to assign one of the team members to the job of trade rep and the other the job of trade department).
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