EFFICIENCY LOSS AND TRADABLE PERMITS



emission reducing devices installed, the traditional marginal cost approach would
underestimate both the cost and the market price of permits. Hence, they tend to
underestimate the costs of abatement faced by firms and overstate the cost-savings
resulting from permit trading programs. If an emission reduction technology (or
equipment) is expensive, many firms would opt to buy emission permits rather than
install that technology unless the equipment has a long lifetime.

This study presents a methodology that incorporates the independent, optimizing
behavior of individual participants of a new trading market in Taiwan. To accomplish
this objective, a price endogenous dynamic mathematical programming model will be
developed that simulates the firms’ behavior and determines the efficiency loss,
optimal technology adoption and permit trading decisions.

KPERMS - Background

Kaohsiung and Pingtung county is the main area where the electric and gas,
paper, fabric and metal, manufacturing, petroleum refining and chemicals industries
are concentrated. Its booming industrial activities in the past 20 years have made the
county a major base for Taiwan's industrial development. However, the emission of
NO
x from these highly polluted industries has often caused the air quality fail to meet
the standards and lead to serious health damages. As opposed to the early days’
command and control policy, Taiwan has adopted an incentive-based instrument to
revise the air pollution control regulations in recent years. For example, an air
pollution fee was introduced in 1995 to ensure that air quality in Taiwan can reach a
comparable level to that of developed nations. In addition, the Environmental
Protection Administration (EPA) of Taiwan has further promulgated that, in 2007
Kaohsiung-Pintung area will launch the first tradable permit system for NO
x control.
The program is so called the Kaohsiung-Pintung emission reduction market system
(KPERMS).

The EPA plans to set gradually tightening emission standards and continues to
promote improvement of air quality through KPERMS. However, the affected sources
are very concerned about the new trading program. This is because improved
emission reduction technologies are sometimes very expensive to install
1 and are
typically lumpy or indivisible. Thus, no contentious agreement has been made so far
about the details of KPERMS such as the target reduction levels, duration of permits
and extension to which firms should be included in the program.

Even though the draft of KPERMS has not been finalized, it is natural to assume
that this program will follow the features of the existing programs such as RECLAIM
and Acid Rain Program. Thus, in this study we assume that the future trading program

1 Chu (1998) present examples with installation costs over one million $US.



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