The CO2 cost pass-through and environmental effectiveness in emission trading schemes

Abstract In this paper, we theoretically investigate the issues of CO2 cost pass-through and environmental effectiveness in emission trading schemes by virtue of a Stackelberg equilibrium. We characterize the equilibrium output and price of energy product, and construct analytical derivations of CO2 cost pass-through rates. Our findings indicate that after the introduction of emission trading scheme, CO2 costs of energy firms are not over-shifted to energy consumers, energy supplies and demands are not excessive distortion as well. Compared to some known results, we prove that the environment effectiveness of emission trading scheme can be improved by the Stackelberg equilibrium under mild conditions. Our main results add to the theory of emission trading scheme by developing a framework where we allow for multi-stage games with observed actions, and present an optimal competition mechanism to optimize CO2 costs and CO2 emissions in emission trading schemes as well. More importantly, the optimal competition mechanism provides regulators and policy makers important information that can be used to design efficient and effective energy policies to trad off energy production, consumption and environmental objectives in emission trading schemes.