Abstract
This article focuses on the strategic behavior of firms in the output and the emissions markets in the presence of market power. We consider the existence of a dominant firm in the permit market and different structures in the output market, including Cournot and two versions of the Stackelberg model, depending on whether the permit dominant firm is a leader or a follower in the output market. In all three models, the firm that dominates the permit market is more sensitive to its initial allocation than its competitor in terms of abatement and less sensitive in terms of output. In all three models, output is decreasing and the permit price is increasing in the permit dominant firm’s initial allocation. In the Cournot model, permit dominance is fruitless in terms of output and profit if the initial allocation is symmetric. Output leadership is more relevant than permit dominance since an output leader always tends to, ceteris paribus, produce more and make more profit whether it also dominates the permit market or not. This leadership can only be overcompensated for by distributing a larger share of permits to the output follower, and only if the total number of permits is large enough. In terms of welfare, Stackelberg is always superior to Cournot. If the initial permit allocation is symmetric, welfare is higher when the same firm dominates the output and the permit market at the same time.
Highlights
A coordinated and effective global agreement to cut down greenhouse gas emissions is far from being reached after 20 years of formal negotiations since the first big attempt in Kyoto, 1997
The role of market power and the method used to do the initial allocation of permits are among the main issues that have attracted the attention of researchers
This paper studies the strategic interaction of polluting firms4 taking part in the output and the permit market, paying attention to the market power position of each firm in each market
Summary
A coordinated and effective global agreement to cut down greenhouse gas emissions is far from being reached after 20 years of formal negotiations since the first big attempt in Kyoto, 1997. Reference [16] simulates the California electricity market by building a Cournot-fringe setting in term of output and permits and show that the Cournot firms can raise energy and permit prices, resulting in a loss of social welfare Our approach in this second version is similar to [7] but with a couple of significant differences. Reference [17] argues that the USA’s rejection to join this Protocol was due to the fact that its least costly strategy to meet the Kyoto requirements would involve buying a large number of emissions credits from Russia This situation can be captured in a simple stylized way by stating that Russia was (or the USA thought it was) a leader in the permit market. The Appendix A contains the proofs of all the analytical results
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