Quantities with Prices: Price-Responsive Allowance Supply in Environmental Markets

Price-responsive emissions allowance supply is more efficient than a pure quantity (cap) or price-based (tax) approach to environmental regulation in the presence of compliance cost uncertainty.Emission reductions from companion policies become additional to an emissions cap under a price-responsive allowance supply, enabling companion policies to help ratchet up program stringency over time.Price-responsive supply is generally introduced as a step function. More price steps in the allowance supply schedule will tend to reduce price and revenue variability under uncertainty.In the electricity sector, a flatter allowance supply schedule has less revenue variability when demand for allowances falls below expected levels although it brings greater emissions variability.Price-responsive supply can reduce the costs of administrative program adjustments, making the policy more durable, and increasing the influence of carbon pricing in driving emissions reductions moving forward.Simulation modeling and behavioral experiments demonstrate price-responsive supply schedules are easy for actors to understand and practical to implement.