Trading and Efficiency © 1998 Peter Berck

Firm’s Bid for Clean Air Services Profits as a function of TBES p(P,TBES) = P Q(.) - C(Q(.),TBES) where Q(.) is the supply function Firms will bid the amount of additional profits they could make from one additional unit of air (TBES+1) to receive one additional unit of air. Bid(TBES) = p(P,TBES+1)-p(P,TBES)

Bid in terms of Cost Bid(TBES) = p(P,TBES+1)-p(P,TBES) Bid(TBES) = C(Q(.), TBES) - C(Q(.), TBES+1) The amount that total cost decreases when the firm is allowed to use one more unit of clean air (pollute one ton more) Result depends upon envelope theorem: that the changes in Q(.) do not matter.

Bid as a function of TBES Bid = change in total cost/change in pollute Bid tons of S emitted (units of air used up)

Fixed Amount of Air: Two Firms Read firm 1 from right Read firm 2 from left Point splits total between the firms. $/unit Total Tons To be Emitted Firm 1 emissions Firm 2 emissions tons of S emitted (units of air used up)

How much Air to each? Intersection minimizes total cost Treating firms the same has losses 50/50 split Bid 1 Bid 2 tons

Dead Weight Loss 50/50 split Bid 1 Bid 2 tons

Losses Older studies show that the total cost of achieving clean air is much higher with a uniform TBES than it would be with TBES set for each firm. California appears as the exception Still don’t know what the most recent work says Assume the regulators learned.

Avoiding loss Trading. let plants within a firm let firms within an airshed Jointly meet standards Firm with higher MC at the standard buys right to pollute from firm with lower MC Both have more money Pollution is same.

However When two firms trade the spatial distribution of the pollution will be different. Trading can be a mechanism to inflict pollution on the poor. Trading can lead to pollution in places that are more sensitive--have more people and more health damage