Emissions Trading Subject to Kantian Preferences

Abstract

We study a cap-and-trade market equilibrium where different regions belonging to an emissions trading regime have different ambitions about the stringency of the cap. Specifically, we introduce a segment of consumers with Kantian preferences and show that they would prefer a more stringent cap compared to other regions. When a region sets up a voluntary more stringent cap within a cap-and-trade market, dual carbon markets with dual prices on allowances can emerge with trade against both caps. We then show that labelling a subset of the allowances in a cap-and-trade market captures the higher willingness to pay driven by different ambition levels among agents within a trading scheme. We show under what circumstances a socially efficient outcome from carbon markets can be achieved by labelling allowances when there are heterogeneous preferences among regions about the ambition level in an emissions trading regime. Being voluntary, trade in labelled allowances is consistent with a bottom-up approach where efforts are built up gradually by actors, countries and regions that wants to take leadership in international climate policy.