Emissions trading with profit-neutral permit allocations

This paper examines the impact of an emissions trading scheme (ETS) on equilibrium emissions, output, price, market concentration, and profits in a generalized Cournot model. We develop formulae for the number of emissions permits that have to be freely allocated to firms to neutralize the profit impact of the ETS. We show that its profit impact is usually limited: in a Cournot oligopoly with constant marginal costs, total industry profits are preserved so long as freely allocated permits cover a fraction of initial emissions that does not exceed the industry's Herfindahl index.

► Examines impact of an emission trading scheme on an imperfectly competitive industry ► Derives bounds on level of free permit allocation needed to preserve industry profits ► Under plausible conditions, output and emissions decline while concentration rises. ► Profit-neutral allocation bounded above by Herfindahl index for Cournot competition.