A Model of Supply and Demand for Tradable Pollution Permits with Application to the Korean Industrial Sectors

Abstract

We suggest a model of supply and demand for tradable pollution permits based on the polluters’ marginal abatement cost (MAC) curves. Assuming linear MAC curves, we derive their parameters based on the estimates of directional output distance functions due to Fare, Grosskopf, Noh and Weber (2005). This model is then applied to the seven industrial sectors in Korea for the period between 2001 and 2009 assuming a target reduction level of the emissions of twenty percent. We find that the introduction of the tradable pollution permits system results in significant cost savings on the order of 46% to 80% of the opportunity costs that would be incurred in case the pollution levels were to be reduced by twenty percent by each enterprise in the economy. This study offers a practical way of estimating the amount by which the costs of reducing industrial pollution may be lowered as a result of the introduction of a system of tradable pollution permits.