Emissions Trading with Profit-Neutral Permit Allocations
This paper examines the impact of an emissions trading scheme (ETS) on industry output price costs emissions market shares and proits. We develop formulae for the number of emissions permits that have to be freely allocated to firms in order to neutralize any adverse impact the ETS may have on proits. Under quite general conditions industry proits are preserved so long as firms are freely allocated a fraction of their total demand for permits with this fraction lower than the industry’s Herfindahl index. Our results have important implications for ETS design especially for its ability to raise government revenue.