The Pollution Game: A Classroom Game Demonstrating the Relative Effectiveness of Emissions Taxes and Tradable Permits

Abstract

This classroom game illustrates the strengths and weaknesses of various regulatory frameworks aimed at internalizing negative externalities from pollution. Specifically, the game divides students into three groups—a government regulatory agency and two polluting firms—and allows them to work through a system of uniform command-and-control regulation, a tradable emissions permit framework, and an emissions tax. Students observe how flexible, market-oriented regulatory frameworks can outperform inflexible command-and-control. More important, given the ongoing debate about how best to regulate carbon dioxide emissions, students also can observe how the introduction of abatement-cost uncertainty can cause one market-oriented solution to outperform another.

Keywords:

• classroom experiments
• emissions taxes
• pollution
• tradable emissions permits

JEL codes:

• A20
• Q52
• Q53
• Q54
• Q58

The author especially thanks the organizers of and participants in the 2008 Allied Social Science Association Annual Meeting, where this article was first presented. The author also thanks three anonymous reviewers for their helpful comments and suggestions.

Notes

1. Figures depicting marginal benefit, marginal cost, and deadweight loss under both scenarios are available for download at http://economics.kenyon.edu/corrigan/pollutiongame/.

2. For large classes, the instructor may wish to divide students into two or more economies, each with its own regulatory agency and industries.

3. Full versions of the instructions and other useful ancillary materials are available for download at http://economics.kenyon.edu/corrigan/pollutiongame/.

4. Although the instructions are written assuming that the regulator's goal is to maximize society's overall well-being, the instructor may choose to offer the regulator the option of choosing its own objective, taking a moment to point out the strengths and weaknesses of each approach. For example, the regulator can choose to minimize pollution, but this will impose a high cost on firms and, eventually, their customers. Conversely, the regulator may choose to maximize permit or tax revenue, although depending on the elasticity of firms’ pollution demand, this may lead to either too much pollution or too little pollution relative to the socially optimal level.

5. An instructor wishing to devote more attention to strategic interaction may wish to introduce a Kwerel mechanism. Kwerel (1977) shows that when the regulator (1) issues Z′ permits such that the marginal benefit from abatement equals the industry's stated marginal abatement cost, and (2) commits to buying back unused permits at a price equal to the marginal benefit from abatement at Z′, firms can do no better than to accurately report their costs. This would, among other things, serve as a starting point for a discussion of the larger mechanism design literature. However, this approach also adds time and complexity to the exercise. See English and Yates (2007) for a current and accessible review of the recent literature.