Emissions Trading, Electricity Industry Restructuring and Investment in Pollution Abatement

K_ni, multiplied by the interest cost of holding capital s_n. The coefficients β^v and β^κ
indicate how the firm weights capital costs and variable operating costs respectively
in the compliance decision.

When comparing the costs and benefits across compliance alternatives, any terms
that do not differ across alternatives will not come to bear on the compliance decision.
I assume that the manager chooses v_ni to minimize the following levelized annual
compliance cost function (substituting for the constraint):

min ZnCni   ^β_n^vniQ_n T ^β_n ^sn^Zn^Kn^(vni⁾ ↑                     (2⁾

Qn

where

_z      r_n(l + ∣n)^τ

^{n -} (l + rn)^τn - l.

The Q_n denotes the quantity of electricity (in kWh) that the manager expects
the nth unit to produce in an average ozone season.¹³ The levelized annual cost factor
Z_n is a function of the firm’s discount rate (r_n) and investment time horizon T_n.

Minimization of the above constrained optimization problem implies :

K' (_v ■) _-__^βnQn

^Kn^(Vni)      _β κ _z

^βn ^sn^zn

The manager will want to choose the point on the compliance curve where the
(negative) slope is equal to the ratio of the cost of an incremental change in variable
compliance costs and the cost of an incremental change in fixed compliance costs. A
relative increase in θ^υ_n(θ^κ) will cause the firm to choose a point on the compliance
frontier where the slope is more (less) steep. Similarly, an increase in the cost of
capital or levelized cost factor will, ceteris paribus, be associated with a less capital
intensive compliance choice.

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