Choosing Winners and Losers in a Classroom Permit Trading Game

Abstract

In many economics classes, from principles to environmental economics and public finance, we teach students that tradable pollution permits are an efficient way to achieve the socially optimal level of pollution. This can be shown to students relatively easily using standard firm cost curves or simply by discussing how firms that can cheaply reduce their pollution can sell their rights to firms with higher pollution reduction costs.' It is often more difficult to convince students that for a fixed level of permits, the initial allocation of permits does not affect the efficiency of the trading program but only the distribution of the financial burden of reducing pollution.2 Understanding the distributional effects of trading programs is important because equity issues are what make some trading programs controversial. For example, the initial allocation of permits is one of the contentious issues in developing an international tradable permit program for greenhouse gas emissions. To illustrate the distributional effects of a permit-trading program, we have developed a simple classroom game. This game can also be used more generally to show how the distribution of property rights determines who internalizes an externality but does not affect whether the social optimum is achieved. This game can be conducted in a 50-minute class with a short follow-up discussion in the next class period and requires only a deck of playing cards, index cards, and copies of the instructions and record sheets in the Appendix.3