Price-Responsive Supply in Environmental Markets

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U.S. Dollars
September 1, 2020

Non-Staff Authors: Dallas Burtraw, Karen Palmer, Charles Holt

Environmental policy with uncertainty is often posed as a choice between price and quantity instruments. Paradoxically, this economic advice employs architecture derived from a first-best global framework that applies imperfectly to the partial-equilibrium, multifaceted regulatory policy setting where it is applied. This paper evaluates instrument design and the evolution of environmental pricing in this sequential policy environment. Quantity “cap” instruments are more often used in practice. Recently, however, automatically adjusting emissions allowance supply schedules have been emerging in existing trading programs. We propose a conceptual framework for a price-responsive supply schedule and use simulation modeling and laboratory experiments to explore its performance and design, including its application in a specific regional market. A price-responsive supply schedule offers efficiency advantages over either a price or a quantity instrument and preserves the roles for technology and energy policies that are expected to lower costs over time.