Endogenous market structures in non-cooperative international emissions trading

The literature on cost-effective international emissions trading (IET) assumes exogenous market structures. This paper develops a game-theoretical model along with numerical simulations for the world economy in order to analyze the equilibrium market structures of an IET scheme. Countries’ decisions regarding the exercise of market power and their initial permit endowments are made non-cooperatively, being guided by their national self-interest. The theoretical results show that both price-influencing and price-taking countries choose an optimal permit endowment in light of their damage costs. Low-damage (high-damage) countries choose more emission permits and act as permit sellers (buyers). The numerical results further suggest that an imperfectly competitive IET market with all price-influencing countries being permit buyers (sellers) has lower (higher) emissions than a perfectly competitive IET market. Finally, the IET scheme has an equilibrium market structure of imperfect competition where the high-damage European Union acts as a unique price maker. This equilibrium imperfectly competitive IET has the lowest global emissions.