Global Trade in C02 Permits: A Classroom Experiment

Denise Hazlett and Laura Bakkensen
    This classroom experiment demonstrates the effects of three different policy scenarios, each designed to achieve the same aggregate reduction in CO2 emissions. Students, taking the roles of managers of electrical power companies, respond first to an across-the-board limit on each firm’s emissions. Next, they participate in a national market for tradable CO2 permits. Finally, their governments allow international trade in the permits. National permit trade improves on across-the-board limits, because it allows low-productivity, low-abatement-cost firms to abate and/or cut their electricity production, thereby freeing up their permits to sell to other firms. Global permit trade produces even higher aggregate profits and output of electricity, because it takes full advantage of the lower abatement costs in the developing country and the higher productivity in the developed country. However, some firm’s profits fall when global permit trade equalizes the worlds price of a permit. Under the parameters of our experiment, enough of these losing firms operate in the developing country that its total industry profits decline slightly. Moreover, the developing country’s total electricity output declines significantly under global permit trade. The experiment thus inspires a discussion of the particular issues involved in global versus national permit trade. The experiment works in principles of economics, environmental, international, and macro-development economics courses, with 10-80 students. It consists of a preparatory homework assignment, 50 minutes of class time running the experiment, and 15 minutes of follow-up discussion.