Grandfather-based or benchmark-based: Strategy choice for carbon quota allocation methods in the carbon neutrality era

Abstract

Climate change and extreme weather caused by the greenhouse effect have attracted global attention. Governments and public sectors are beginning to recognize the importance of reducing carbon emissions and have reached a consensus on “carbon neutrality.” This study investigates the strategic choice of carbon quota allocation methods within a supply chain framework, involving a policy maker (government), a manufacturer, and a retailer. At the outset, the government selects either the grandfather-based allocation method (Method G) or the benchmark-based allocation method (Method B) to regulate the manufacturer's carbon emissions. Subsequently, the manufacturer determines the level of carbon emission reduction and wholesale pricing, and the retailer sets the order quantity based on the manufacturer's decision. Drawing on equilibrium outcomes, this research compares the optimal decisions of firms, carbon emissions, consumer surplus, overall social welfare, and supply chain sustainability under these two methods. The research highlights several major findings. First, regardless of which allocation method is adopted, a rise of the initial carbon emission in producing process will lead to an increase in the wholesale price, but a decrease in emission reduction level and the order quantity. Second, under method B, the manufacturer reduces more carbon emission. Third, from the social welfare perspective, the method B/G is a better choice for the government when the environmental damage coefficient is relatively low/high. Fourth, when carbon quota and the initial carbon emission meet some certain conditions, the method B can achieve environmental sustainability and economic sustainability.