Unpublished Paper
Capacity coordination and strategic underproduction under cap-and-trade
(2021)
Abstract
This paper presents a two-stage game of cap-and-trade (CAT) regulated production. We show how
quantity-based regulation, in the form of individual production or pollution emissions permits, can function
as a credible commitment device allowing firms to coordinate their own-production levels and underproduce
the quantity cap set by the regulator. Under strategic underproduction equilibria, consumer
surplus and production cost efficiency declines, but industry profits increase. This channel for exercising
market power under CAT has been overlooked and requires new regulatory countermeasures. Limiting
permit accumulation by individual firms can restore first best efficiency but only under specific industry
and cost conditions. We show that a poorly designed ownership limit policy can reduce welfare below
levels attained without limits. A case study of the U.S. west coast groundfish fishery which is currently
regulated under CAT with strict limits on ownership of fishing permits is presented. Evidence of strategic
underproduction is inconclusive. We find current ownership restrictions likely prevent firms from realizing
economies of scale in production. Alternate policies to counter strategic underproduction forces are
recommended.
Keywords
- Cap-and-trade regulation,
- market power,
- strategic underproduction,
- permit ownership limits.
Disciplines
Publication Date
Winter December 15, 2021
Citation Information
Xinyu Guo, Desire Kedagni and Quinn Weninger. "Capacity coordination and strategic underproduction under cap-and-trade" (2021) Available at: http://works.bepress.com/quinn-weninger/40/