Multipollutant Cap-and-Trade Systems with Heterogeneous Firms: An Optimal Transport Approach
This paper proposes a multipollutant cap-and-trade system that accounts for emission interactions to reduce pollution and protect public health.
Abstract
The simultaneous exposure to multiple air pollutants has become a pressing concern for policymakers seeking integrated market-based instruments to address this challenge effectively. In this paper, I develop and analyze a multipollutant cap-and-trade system encompassing a diverse array of polluting firms and an independent pollution control authority responsible for issuing multipollutant permits. Each permit encapsulates distinct pollutant rights, reflecting a spectrum of types and quantities of pollutants bundled together. I assume that the control agency knows the aggregate heterogeneity distribution of the firms, which accommodates situations where it may lack granular information on individual firm pollution profiles (private data). The crux of the challenge resides in efficiently allocating the diverse array of permits across the heterogeneous pool of firms. To address this, I leverage optimal mass transportation techniques to establish the presence of an optimal allocation strategy for permits among heterogeneous firms. This allocation process is found to be decentralized, with equilibrium prices of permits enabling me to derive a geometric characterization of the firms involved based on their self-selection of permits. The intricate interplay between the distribution of firms, spectrum of permits, and firms’ heterogeneity in payoff reveals strategic choices in permit selection and the emergence of market segmentation within the cap-and-trade framework. I also address the question of whether separated markets for individual pollutants can replicate the outcomes of a multipollutant cap-and-trade market. Numerical simulations employing computational geometry and optimal transport techniques illustrate the determination of permit prices and the optimal demand partition within a multipollutant cap-and-trade market.
Keywords: Multipollutant Permits, Cap-and-Trade Markets, Environmental Policy, Heterogeneous Firms, Matching, Optimal Mass Transport.
JEL Classification: Q5, Q58, D82, C6
