Market Power, Intertemporal Permits Trading, and Economic Efficiency

Abstract

The banking and borrowing (BB) system has been developed gradually in the tradable permits market to perform a role as an environmental management tool. One question naturally arises as to how it will impact the behaviors of firms and the efficiency in presence of market power in the permits market. This paper considers market power in two cases: with and without the BB system. The equilibrium behaviors of the firms are identified in two cases. The findings show that the producing and discharging behaviors of firms depend on the permits price elasticity of output price without BB system, while they only depend on the growth rate of the output price in the BB system. Although both cases fail to obtain efficient solutions, the market with a BB system is capable of alleviating the inefficiency arising from market power compared with that without a BB system. The path of permits price satisfies the Hotelling rule in the case of the BB system, while it is closely related to the path of output price and output price elasticity of permits price in the case without the BB system.