Game-theoretic analysis for an emission-dependent supply chain in a ‘cap-and-trade’ system

Abstract

The paper focuses on the impact of emission ‘cap-and-trade’ mechanism in a so-called emission-dependent supply chain with the emission permit supplier and the emission-dependent firm. In the cap-and-trade system, emission permit becomes one of key factors of production for emission-dependent firms. Two major sources of emission permits are considered—emission cap/quota imposed by the government, and permits purchased via emission trading. If the quota is insufficient to satisfy the target production, extra permits should be purchased via trading. In this case, the traditional non-profit green organizations may be endowed with the role of emission permit suppliers. Thus, the introduction of market mechanism injects new life into environment protection. In the context of newsvendor, the paper investigates the behavior and decision-making of each member in the emission-dependent supply chain. A game-theoretical analytical model is proposed and the unique Nash equilibrium is derived. In their own self-interest, the emission permit supplier and the emission-dependent firm make their optimal decisions on permits pricing and production quantity respectively. Players’ bargaining power in the game is affected by several exogenous factors, such as the governmental environment policy, the market risk, etc. Several valuable managerial insights on bargaining power affected by external factors (such as environmental policies, market risks, etc.) are further concluded.