Optimal Regulations and Efficiency Losses in Imperfectly Competitive International Emissions Trading

This paper analyzes governments’ optimal regulations and efficiency losses under imperfectly competitive international emissions trading in which price-influencing and price-taking countries move sequentially. It is found that price-taking countries should not intervene in trading of emission permits. As for the price-influencing group, no regulation is optimal when only one country has market power. In contrast, if there are at least two price-influencing countries, it is optimal for them to subsidize their firms’ permit purchases or sales. We show that the subsidies could mitigate efficiency losses of countries adopting this policy, given other countries’ optimal regulations. Moreover, a numerical example of the Annex-1 emissions trading is conducted to support our theoretical results. The simulation results further show that the number as well as the composition of price-influencing countries would affect total efficiency losses under imperfectly competitive international emissions trading.