Endowment Game and Optimal Total Quantity in the Market for Tradeable Permits

Abstract

The paper extends previous literature on tradable permits in two directions. First, the initial allocation of permits is modeled as a cooperative bargaining game between participants of the subsequent market. Using this framework, it is shown how market structure affects the connection between ‘Utilitarian’ ‘Nash’ and ‘Equal Gains’ allocation principles. Second, the total quantity of permits is made endogenous through the introduction of a social planner maximizing social utility. The effects of both market structure and rules of allocation on optimal total quantity are described. Results are used to evaluate related aspects of International Emission Trading established by the UN’s 1997 Kyoto protocol.