Journal of Regulatory Economics

, Volume 44, Issue 1, pp 80–102 | Cite as

Prices versus quantities: environmental regulation and imperfect competition

Original Article

Abstract

By exercising market power, a firm will distort the production, and therefore the emissions decisions, of all firms in the market. This paper examines how the welfare implications of strategic behavior depend on how pollution is regulated. Under an emissions tax, aggregate emissions do not affect the marginal cost of polluting. In contrast, the price of tradable permits is endogenous. I show when this feedback effect increases strategic firms’ output. Relative to a tax, tradable permits may improve welfare in a market with imperfect competition. As an application, I model strategic and competitive behavior of wholesalers in a Mid-Atlantic electricity market. Simulations suggest that exercising market power decreased emissions locally, thereby substantially reducing the regional tradable permit price. Furthermore, I find that had regulators opted to use a tax instead of permits, the deadweight loss from imperfect competition would have been even greater.

Keywords

Environmental regulation Market based instruments   Imperfect competition Electricity restructuring 

JEL Classification

H23 L11 L94 

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Copyright information

© Springer Science+Business Media New York 2013

Authors and Affiliations

  1. 1.Dartmouth College and NBERHanoverUSA

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