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Moral Hazard and Tradeable Pollution Emission Permits

Author

Listed:
  • Alvarez Francisco

    (Department of Fundamentos del Análisis Económico II, Universidad Complutense, 28223 Pozuelo de Alarcon, Madrid, Spain)

  • Camiña Ester

    (Department of Fundamentos del Análisis Económico II, Universidad Complutense, 28223 Pozuelo de Alarcon, Madrid, Spain)

Abstract

We consider a market for pollution emission permits in a model in which pollution, generated as by-product of firm’s activity, is determined as the sum of firm-specific random shocks and each firm’s abatement effort. In such a setting, an expected utility maximizing society demands an efficient abatement effort from each firm. We assume that the abatement effort is decided by each firm and is not observed by the environmental regulator. This leads to a moral hazard problem between firms (agents) and the regulator (principal). The regulator assigns contracts to each firm, each contract consisting of an amount of permits and a linear fine for over-polluting firms. We distinguish those policies where the regulator assigns a low number of permits (restrictive policies) and policies where the number of permits to distribute is high (permissive policies). We show that in a context of restrictive policies there exist policies that achieve efficiency and do not need to discriminate in terms of penalties among over-polluting firms when a market for permits is allowed to operate. We also find that the regulator can set up policies with low penalty levels for almost all firms. Finally, we show that in a context of permissive policies, the market leads to the same efficiency-inducing fine scheme than the corresponding one under autarky.

Suggested Citation

  • Alvarez Francisco & Camiña Ester, 2014. "Moral Hazard and Tradeable Pollution Emission Permits," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 14(1), pages 415-444, January.
    • Handle: RePEc:bpj:bejtec:v:14:y:2014:i:1:p:30:n:16
    DOI: 10.1515/bejte-2013-0072
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    References listed on IDEAS

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    1. Innes, Robert, 2003. "Stochastic pollution, costly sanctions, and optimality of emission permit banking," Journal of Environmental Economics and Management, Elsevier, vol. 45(3), pages 546-568, May.
    2. Springer, Urs, 2003. "The market for tradable GHG permits under the Kyoto Protocol: a survey of model studies," Energy Economics, Elsevier, vol. 25(5), pages 527-551, September.
    3. Macho-Stadler, Ines & Perez-Castrillo, David, 2006. "Optimal enforcement policy and firms' emissions and compliance with environmental taxes," Journal of Environmental Economics and Management, Elsevier, vol. 51(1), pages 110-131, January.
    4. Xepapadeas, A. P., 1991. "Environmental policy under imperfect information: Incentives and moral hazard," Journal of Environmental Economics and Management, Elsevier, vol. 20(2), pages 113-126, March.
    5. Plourde, Charles & Yeung, David, 1989. "A model of industrial pollution in a stochastic environment," Journal of Environmental Economics and Management, Elsevier, vol. 16(2), pages 97-105, March.
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    More about this item

    Keywords

    moral hazard; emission permits market; efficiency-inducing policies;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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