Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)
Trading for the Future: Signaling in Permit Markets
() and Gunnar S. Eskeland
Abstract: Permits markets are celebrated as a policy instrument
since they allow (i) firms to equalize marginal costs through trade and
(ii) the regulator to distribute the burden in a politically desirable way.
These two concerns, however, may conflict in a dynamic setting.
Anticipating the regulator's future desire to give more permits to firms
that appear to need them, firms purchase permits to signal their need. This
raises the price above marginal costs and the market becomes inefficient.
If the social cost of pollution is high and the government intervenes
frequently in the market, the distortions are greater than the gains from
trade and non-tradable permits are better. The analysis helps to understand
permit markets and how they should be designed.
Keywords: Tradable permits; time inconsistency; the ratchet effect; rent-seeking; plan vs. market; (follow links to similar papers)
JEL-Codes: Q50; (follow links to similar papers)
47 pages, March 26, 2010
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