Bilateral Oligopoly, Private Information, and Pollution Permit Markets

Abstract

We analyze the effects of strategic behavior and private information in pollution permit markets in which all firms have market power. The market is characterized by supply-function equilibria. Firms submit net supplies for permits and a market maker selects the market-clearing price. Net supplies depend on abatement cost functions, which in turn depend on private information parameters. We determine the increase in aggregate abatement costs due to strategic behavior and private information and show that private information attenuates the effects of strategic behavior. We evaluate the common practice of assigning endowments as a simple proportion of historical emissions.

Keywords: bilateral oligopoly, pollution permits, private information

JEL Classification: Q5, L13, D43, D82