IVL Swedish Environmental Research Institute

An important feature in the design of an emissions trading program is how emissions allowances are initially distributed into the market. In a competitive market the choice between an auction and free allocation should, according to economic theory, not have any influence on firms' productionchoices nor on consumer prices. However, the debate around current emissions trading systems shows that parts of industry, the general public and policy making community expect the method of allocation to affect product prices. This paper reports on the use of experimental methods to investigate behavior with respect to how prices will be determined under a cap?and?trade program with different allocation methods. Participants initially display a variety of pricing strategies. However, given a simple economic setting in which earnings depend on behavior, we find that subjects learn to consider the value of allowances and overall behavior moves toward that predicted by economic theory.

An important feature in the design of an emissions trading program is how emissions allowances are initially distributed into the market. In a competitive market the choice between an auction and free allocation should, according to economic theory, not have any influence on firms' productionchoices nor on consumer prices. However, the debate around current emissions trading systems shows that parts of industry, the general public and policy making community expect the method of allocation to affect product prices. This paper reports on the use of experimental methods to investigate behavior with respect to how prices will be determined under a cap?and?trade program with different allocation methods. Participants initially display a variety of pricing strategies. However, given a simple economic setting in which earnings depend on behavior, we find that subjects learn to consider the value of allowances and overall behavior moves toward that predicted by economic theory.