The choice of cap-and-trade and carbon tax regulations in a cap-dependent carbon trading price setting

Abstract

Purpose

The purpose of this paper is to analyze the operational decisions of a manufacturer who produces multiple products and the government's selection of cap-and-trade and carbon tax regulations.

Design/methodology/approach

This paper explores the production decisions of a multi-product manufacturer under cap-and-trade and carbon tax regulations in a cap-dependent carbon trading price setting and compares carbon emission, the manufacturer's profits and social welfare under the two regulations. Game theory and extreme value theory are used to analyze our models.

Findings

First, the authors find that the optimal profit of the manufacturer (the optimal cap) increases and then decreases with the cap (the unit carbon emission of product). Second, if the environmental damage coefficient is moderate, the optimal cap of unit environmental damage coefficient is independent of the product carbon emission or other related product parameters. Ultimately, cap-and-trade regulation always generates more carbon emission than carbon tax regulation. And cap-and-trade regulation (carbon tax regulation) can generate more social welfare if the environmental damage coefficient is low (high), and the social welfare under the two regulations is equal to each other, or otherwise.

Originality/value

This paper contributes the prior literature by considering the inverse relationship of the allocated cap and the carbon trading price and discusses the social welfare under cap-and-trade and carbon tax regulations. Some important and new results are found, which can guide the government's implementation of the two regulations.

Citation

Xu, X., Yu, Y., Dou, G. and Ruan, X. (2022), "The choice of cap-and-trade and carbon tax regulations in a cap-dependent carbon trading price setting", Kybernetes, Vol. 51 No. 8, pp. 2554-2577. https://doi.org/10.1108/K-09-2020-0610