Duopolists in Output and Permit Markets: Interaction and Regulation

This paper studies the interaction between and the regulation of duopolists in imperfect permit and output markets. The interaction is modeled with a two-stage game in which the permit holding decision is made after the output decision. In the case of dominant buyer this results in a larger total output compared to the output level when the permit markets are perfect but the output market is imperfect. The opposite result holds for dominant sellers. In addition, the second-best regulation is characterized. It is shown that subsidies for permit buying and taxes for permit selling can be used as instruments to increase efficiency in both markets.