Ineffectiveness of carbon cap-and-trade market

Abstract

Under neoclassical assumptions, this paper develops a model to illustrate the effects of government use of carbon allowances for carbon emission control. We find that control using the instrument of issuing long-term carbon allowances does not produce the same good results in the Decentralised Equilibrium as in the Planning Problem. Thus, while Coase's Theorem ensures that the Pareto optimum is maintained in an economy with multiple agents, it does not align the social development with the economic optimum of the planner. We believe this is due to the that the price of carbon allowances is determined by asset profiles of investors rather than externalities. The steady-state under the special pathway shows that consumption is determined by the rate of technological progress, the total amount of carbon dioxide at steady-state, the level of technology at which steady-state is reached and the total amount of carbon allowances remaining. The comparison with the optimal tax path reveals that the price of carbon allowances has increased too quickly, leading to excessive consumption of fossil fuels in the early stages.