Pollution Rights Trading Game

Nugent, Rachel A. "Teaching Tools: A Pollution Rights Trading Game." Economic Inquiry. 35 (July 1997) 679-685.

This classroom game demonstrates the efficiency benefits of market-based incentives for pollution control. The materials needed for this exercise include a chart for each industry so costs of alternative approaches can be calculated, certificates for emission credits, and a regulator (instructor) of the game. The key ideas for the students to consider are the regulatory agency’s goal of reducing polluting emissions and the companies’ goal of minimizing the costs of any pollution reduction they are forced to make. The class is divided into small groups (minimum 2—manager & trader) to represent companies emitting a pollutant. Each company faces a different schedule of pollution abatement costs, based on its product and technology, for the same pollutant. For simplicity, use a constant marginal cost of abatement schedule (advanced—rising marginal cost). Each company is given a simple formula relating profit levels to output. The small groups complete Table 1 to become familiar with their company’s profit and pollution levels. Then the regulator imposes an emissions limit (50% reduction). The regulator distributes a predetermined number of emission permits equally to the companies as indicated in the Tables. Each company completes Table 2, calculating the costs of available options. Then permit trading occurs for a limited amount of time. If the company does meet the regulations, the regulator will shut down the company, incurring a loss of all profits for the next period. An equilibrium price will be established for the pollution rights. After performing the trading scenario(s) students will be ready to address the list of questions in Appendix 2 and discuss their findings. There are several extensions and complications that can be added to the game.