Exploring the effect of cap-and-trade mechanism on firm's production planning and emission reduction strategy

Abstract

Cap-and-trade mechanism has a significant effect on firm's production and operation decisions and carbon emissions. This study develops a mathematical model to examine the effect of cap-and-trade mechanism on firm's production planning and emission reduction strategy. Based on the model, the firm's critical production planning decisions, such as the optimal production quantity, optimal allowance selling price and the maximum profit under the cap-and-trade mechanism are derived firstly. Then based on the cost-benefit analysis, the conditions under which the firm makes the optimal emission reduction strategy between buying carbon allowance from the carbon trading market and conducting low-carbon processing are identified. The result suggests that when the low-carbon processing cost is greater than the potential opportunity benefit, the firm is inclined to purchase carbon allowance from the carbon trading market, and vice versa. Finally, a numerical analysis is conducted to investigate the effects of relevant factors, such as carbon quotas, carbon emission rate, low-carbon processing cost and transaction cost on firm's production and operation decisions. The results indicate that under the cap-and-trade mechanism, the transaction cost has a positive effect on allowance selling price. The firm's optimal production quantity and maximum profit is positively related to carbon quotas, while negatively related to carbon emission rate and low-carbon processing cost. This research contributes to enrich related literature and knowledge with regard to carbon emissions reduction at the firm level and highlight the critical importance of cap-and-trade mechanism in reducing carbon emissions.