Prices vs. Quantities:
Environmental Regulation and Imperfect Competition
Erin T. Mansur
By exercising market power, a firm will distort the production, and therefore the emissions decisions, of all firms in the market. This paper examines how the welfare implications of strategic behavior depend on how pollution is regulated. Under an emissions tax, aggregate emissions do not affect the marginal cost of polluting. In contrast, the price of tradable permits is endogenous. I show when this feedback effect increases strategic firms' output. Relative to a tax, tradable permits may improve welfare in a market with imperfect competition. As an application, I model strategic and competitive behavior of wholesalers in a Mid-Atlantic electricity market. Simulations suggest that exercising market power decreased emissions locally, thereby substantially reducing the regional tradable permit price. Furthermore, I find that had regulators opted to use a tax instead of permits, the deadweight loss from imperfect competition would have been even greater.
“Environmental Regulation in
Oligopoly Markets: A Study of Electricity Restructuring”
UC Energy Institute POWER Working Paper-088, November 2001, Revised September 2004.
SSRN Yale SOM Working Paper No. ES-38 (abstract number 601366), September 2004.
This paper has been split into two papers:
“Prices vs. Quantities: Environmental Regulation and Imperfect Competition” and
“Do Oligopolists Pollute Less? Evidence from a Restructured Electricity Market”