Permit Trading and Credit Trading - A Comparative Static Analysis with Perfect and Imperfect Competition

This paper compares emissions trading based on an absolute cap, denoted permit trading, with a scheme based on relative standards, denoted credit trading, under both perfect and imperfect competition. I show that credit trading is an inefficient instrument and that the two schemes have a different impact on the regulated industry. Credit trading leads to higher total output, higher marginal abatement costs and a higher number of firms in the market than permit trading. Furthermore, under both schemes the total number of firms can both decrease and increase as a result of regulation. I find that under perfect competition, permit trading gives highest welfare, while under imperfect competition, credit trading mostly leads to higher welfare. With foreign competition however, credit trading is more likely to be chosen since this gives a better competitive position for firms.