Coordinating Separate Markets for Externalities

72 Pages Posted: 12 Apr 2018

See all articles by Jose Miguel Abito

Jose Miguel Abito

University of Pennsylvania

Christopher R. Knittel

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Konstantinos Metaxoglou

Carleton University

Andre Trindade

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças

Date Written: April 2018

Abstract

We show that inefficiencies from having separate markets to correct an environmental externality are significantly mitigated when firms participate in an integrated product market. Firms take into account the distribution of externality prices and reallocate output from markets with high prices to markets with low prices. Investment in cleaner and more efficient capacity serves as an additional mechanism to reallocate output, which increases the marginal benefit of investment, and consequently improves longer-term outcomes. Using data from an integrated wholesale electricity market, we estimate a dynamic structural model of production and investment to bound the loss from separate markets for carbon dioxide emissions, and quantify the extent to which optimal investment can compensate for the loss. Despite the lack of the “invisible hand” of a single emissions market, profit-maximizing firms can play a crucial role in coordinating otherwise uncoordinated environmental regulations.

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Suggested Citation

Abito, Jose Miguel and Knittel, Christopher R. and Metaxoglou, Konstantinos and Trindade, Andre, Coordinating Separate Markets for Externalities (April 2018). NBER Working Paper No. w24481. Available at SSRN: https://ssrn.com/abstract=3158920

Jose Miguel Abito (Contact Author)

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

Christopher R. Knittel

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Konstantinos Metaxoglou

Carleton University ( email )

Andre Trindade

Getulio Vargas Foundation (FGV) - FGV/EPGE Escola Brasileira de Economia e Finanças ( email )

Praia de Botafogo 190/1125, CEP
Rio de Janeiro RJ 22253-900
Brazil

HOME PAGE: http://https://sites.google.com/site/andretrindade/

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