Breakdown of the Equi-Marginal Principle in Permit Markets Involving Multiple Pollutants and Exogenous Caps

• Agricultural Economics Workshop

Date and Location

Wednesday, May 25, 2016, 4:10 PM - 5:30 PM
ARE Library Conference Room, 4101 Social Sciences and Humanities

Abstract

Pollution permit trading programs typically focus on individual pollutants, yet many environmental management problems involve multiple pollutants. Hence, potential benefits may arise from developing multi-pollutant strategies that take a more comprehensive approach to environmental management. There is interest in expanding market-based approaches that traditionally involve intra-pollutant trading, or trading “like” pollutants, to allow inter-pollutant trading, or trading across imperfectly substitutable pollutants. We examine the design of a market involving both inter- and intra-pollutant trades when some firms generate multiple pollutants. Our focus is on choosing trade ratios for both types of trades. We also extend prior work on market-based approaches for multi-pollutant problems by examining the second-best design of inter- and intra-pollutant trading ratios when permit caps are inefficient. This is important since permit caps are typically set exogenously in offset programs. We demonstrate analytically that one-for-one intra-pollutant trading is not generally optimal for uniformly mixed pollutants in this setting, regardless of whether inter-pollutant trading is allowed, because the equi-marginal principle is not satisfied. This contrasts with prior work that analyzes inter-pollutant trade ratios when one-to-one intra-pollutant trading rates are assumed due to uniform mixing of like pollutants. We highlight our analytical results using a numerical example of nitrogen trading in the Susquehanna River Basin in Pennsylvania.