Permit Trading and Credit Trading: A Comparison of Cap-Based and Rate-Based Emissions Trading Under Perfect and Imperfect Competition

Abstract

This paper compares emissions trading based on a cap on total emissions (permit trading) and on relative standards per unit of output (credit trading). Two types of market structure are considered: perfect competition and Cournot oligopoly. We find that output, abatement costs and the number of firms are higher under credit trading. Allowing trade between permit-trading and credit-trading sectors may increase welfare. With perfect competition, permit trading always leads to higher welfare than credit trading. With imperfect competition, credit trading may outperform permit trading. Environmental policy can lead to exit, but also to entry of firms. Entry and exit have a profound impact on the performance of the schemes, especially under imperfect competition. We find that it may be impossible to implement certain levels of total industry emissions. Under credit trading several levels of the relative standard can achieve the same total level of emissions.