Tradable Permits and Car Pooling

The SO2 Emissions Trading Program: Cost Savings without Allowance Trades

The paper above talks about a program pollution permits. Firms are given permits that allow them to pollute. If they want to pollute more then they buy more permits. The theory states that when the permits are handed out, firms trading among themselves will push production of the pollution to the most productive polluter. The firm with the high marginal abatement costs will ask the firm with the low marginal abatement cost to produce the pollution. This happens because the firms now must factor into their decisions the cost of pollution, which is the cost of the permits.

Something similar happens in the automotive world. How much pollution a car makes is related to how fuel inefficient it is. There are other factors as well, such as how cleanly the car burns the fuel, but driving a car alone produces carbon dioxide, which results in global warming. How much fuel you burn determines then how much pollution you cause. But in this case drivers must pay for their pollution. If you drive a fuel efficient Prius then because the Prius burns 4.4L/100km then you will pay less per 100km than if you drive a Landcruiser, which averages about 16L/100km, which is almost three times more. What should happen in this case is that the Landcruiser driver who realizes that he is paying so much for fuel will be better off car -pooling with the Prius driver.

In the sulphur dioxide trading program mentioned above, one of the surprises was that although firms were allowed to trade permits among themselves there was actually very little trading done. The paper suggests that high transaction costs may have been a problem. Search costs also may have been high. This is related to the car issue because even though we can expect the Landcruiser driver to want to car pool with the Prius driver, the Landcruiser driver may not even know the Prius driver. Perhaps the Landcruiser driver lives in the country while the Prius driver lives in the city, and in this case the transport costs would be high if the two were to meet each other. Car pooling also requires you to find people who are going to the same place as you are and then to negotiate with them how much they can pay you. So clearly just as there are transaction costs in trading pollution permits among firms there are also transaction costs in car pooling.