Carbon emissions abatement with duopoly generators and eco-conscious consumers: Carbon tax vs carbon allowance

Abstract

With electrification and economic development, global carbon emissions are rising every year. Among them, the power industry accounted for the highest proportion of carbon emissions. To combat climate change, environmental pollution and economic losses caused by greenhouse effect, governments implement low-carbon policies in the electricity market. Considering the impact of generators’ carbon emissions on consumers behaviors and environmental benefit, this paper compares two main emission reduction policies — carbon tax and carbon allowance in a market with two asymmetric generators and a group of heterogeneous eco-conscious consumers. Despite the widespread belief that environmental advocacy hurts economic performance and social welfare, we find that both policies improve social welfare due to price increases or production restrictions. And when neither generator has a significant cost advantage, the social welfare under carbon allowance is higher than that under carbon tax, and the total carbon emissions are lower. This is because the carbon tax indirectly regulates generators’ output and total welfare by affecting prices. While carbon allowance can directly regulate generators’ output through capacity limits, and further improve the total social welfare. Through numerical analysis, the optimal emission reduction strategies of the government under different conditions are determined. We also extend the main model and show that the key results are still valid.