Question

The Regional Greenhouse Gas Initiative (RGGI) is a cap and trade program for controlling emissions of CO2 from electricity generators. Allowances are freely tradable across the RGGI states and unused allowances are bankable to future years. The market for RGGI allowances is competitive. The allowance price is currently $6. Here is a chance to use your understanding of emission markets:

a) Virginia will be under the RGGI cap next year. UVA has decided that next year it will pay to cut its emissions by 100 thousand tons. Half these emission reductions will cost $3 to implement, half will cost $9. Given the current allowance price, explain how to think through what effect these reductions will have on total RGGI emissions and allowance prices.

b) In hot summers, marginal abatement cost (MAC) increases by 50%. In cool summers, MAC falls by 50%. While this summer was a cool one, next summer is expected to be a hot one. What do you think the allowance price will be next summer? Why?

Answer 1

a) allowence price is $6

so for 100 thounsand tons , they got $6*100 = $600 allowence benefit.

now for implementation ,half cost $3 , so , $3*50% of 100=$150

and $9 for half cost = $9*50%100=$450

together = $450+$150=$600

This shows emissions reduced by 100 unit and the allowance price should be fixed at $6 because a price less than $6 would lead to a fall less than 100 thousands tons. So, the $6 is an equilibrium allowance price.

b)In a year MAC is $3 and $9, as the MAC is greater in hotter summer than in cooler summer we can say that MAC is higher in summer than in winter. So, $9 is the cost of redution in summer. Now, a 50% increment for MAC in hot summer so $9 became 9+(50%of 9)=$13.5. A 50% reduction in cool summer so the cost is 9 - (50%of9) = $4.5

The next summer is expected to be hot because this summer is cool. The cost this summer is $9 so the actual cost is x-(50% of x) =9 this implies x = 18. So the cost of reduction in next summer would be 18 + (50% of 18) = $27. Cost of reducing 50% at this price is 27*$50 = $1350 and the cost of reduction in winter remains constant at $3 so for another half cost of reduction is $3*50=$150

total cost of reduction $150+$1350=$1500

so for next summer allowence price should be $1500/100= $15 so as to reduce the emission by 100 units.