Scandinavian Working Papers in Economics

Working Papers,
Swedish National Road & Transport Research Institute (VTI)

No 2009:6: Teaching Opportunity Cost in an Emissions Permit Experiment

Svante Mandell (), Chrles Holt , Erica Myers , Dallas Burtraw and Markus Wråke
Additional contact information
Svante Mandell: Swedish National Road & Transport Research Institute (VTI), Postal: Dept. of Transport Economics, P.O. Box 55685, SE-102 15 Stockholm, Sweden
Chrles Holt: Department of Economics, University of Virginia
Erica Myers: Resources for the Future
Dallas Burtraw: Resources for the Future
Markus Wråke: IVL Swedish Environmental Institute

Abstract: This paper describes an individual choice experiment that can be used to teach students how to correctly account for opportunity costs in production decisions. Students play the role of producers who require a fuel input and an emissions permit for production. Given fixed market prices, they make production quantity decisions on the basis of their costs. Permits have a constant price throughout the experiment. In one treatment, students have to purchase both a fuel input and an emissions permit for each production unit. In a second treatment, they receive permits for free, and any unused permits are sold on their behalf at the permit price. If students correctly incorporate opportunity costs, they will have the same supply function in both treatments. This experiment motivates classroom discussion of opportunity costs and emissions permit allocation under cap-and-trade schemes. The European Union Emissions Trading Scheme provides a relevant example for classroom discussion, as industry earned significant windfall profits from free allocation of emissions allowances in the early phases of the program.

Keywords: opportunity cost; emissions permits; allowance allocation; classroom experiments

JEL-codes: A22; C90; Q52

12 pages, May 25, 2009

Note: The paper is also part of the RFF discussion paper series.

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