EFFICIENCY LOSS AND TRADABLE PERMITS



Conclusion

An economic analysis of the KPERMS, which aims at reducing the air
pollution in the Kao-shiung and Ping-tung county using a tradable permits system, is
presented in this study. Two issues were of particular interest: i) investigate the
economic impacts of the program on participating firms, and ii) analyze possible
efficiency loss due to indivisibility of technology installation of firms in the permit
market. A social planner’s model is developed to determine the socially optimum
pollution abatement and trading strategy. An important feature that makes this study
unique is the incorporation of discrete (binary) decision variables, namely technology
adoption decisions, in an optimization model (a mixed integer program) that simulates
the firms’ decision-making behavior. This characteristic is important because in the
case of KPERMS the pollution control equipments are in general expensive and
one-time fixed costs constitute an important component of the total costs and hence
the firms’ decision-making. Therefore, the model is a more realistic representation of
the actual decision problem than the conventional modeling approach seen in the
permit trading literature where abatement costs involve variable costs only based on
the simplifying assumption that once adopted the abatement technologies will be
utilized at full capacity. In reality, the average cost of abatement under alternative
technology options is endogenously determined depending on the firms’ decisions
regarding the number of permits generated, purchased or sold or banked, all of which
are determined by permit prices over the duration of the emission trading program.

The result shows that when control equipment decisions are indivisible, an
efficiency loss may arise due to over-investment. The option of banking unused ERCs
to future periods would not eliminate the excess supply in the particular case study
(KPERMS) presented here. Rather, it would only defer the efficiency loss to a future
period. Whether a more stringent environmental standard can eliminate excess supply
and decrease the efficiency loss depends on the number of firms participating in
market, the firms’ emission levels, available control technologies and required
reduction rates. When the number of firms is large and their choices over control
equipment vary widely, such losses may disappear and the empirical findings
obtained from the discrete analysis presented here would correspond more closely to
those that would be obtained from a continuous analysis typically used in the
traditional permit trading literature. In that case, the excess supply would diminish
and the permit trading market would be close to equilibrium. In reality, each trading
market focuses on one pollutant and the best available control equipment for that
pollutant usually does not vary much. In that case the firms’ behavior in terms of
choosing their control equipment would be more or less homogenous. However, even

14



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