Tradable performance standards in a dynamic context

Many sectors of the economy that are targets of emissions reduction policy tend to be subject to price-responsive demand, long-lived capital, capacity constraints, and foresighted decision-making. I explore these features together, in conjunction with a tradable performance standard (TPS). First, I provide a complete characterization of the short-run and steady-state output responses analytically. Second, I validate the intermediate analytical results, explore the dynamics of the transition from pre- to post-policy steady-state, and discuss the welfare implications using a stylized numerical equilibrium model calibrated to a representative electricity sector. I show that the difference in the present value of total social surplus gains between a TPS and a period-over-period damage equivalent cap (CAP) is small relative to total social surplus gains from either policy. Most interestingly, under all but the smallest discount rates, the value of the steady-state perpetuity under the TPS is greater than the CAP.