A Laboratory Experiment to Compare Two Market Institutions for Emissions Trading

Abstract

We report results from an economic experiment where two markets institutions for controlling water pollution are compared. In the status quo institution, permit trades between point and nonpoint sources are subject to a trading ratio. In the alternative, nonpoint abatements are converted into permits with multiple attributes. The test bed captures important features of existing markets for water quality trading. First, pollution is stochastic, poorly observed and imperfectly controlled by nonpoints. Second, the market is characterized by oligopsony. The results indicate that the multi-attribute market generates a superior environmental outcome to the trading ratio market. Furthermore, the average cost of pollution control is lower in the multi-attribute market. Market power is found to be independent of the type of market institution, but sellers of permits learn to resist market power as they gain experience. This is at the cost of market efficiency since their resistance reduces the number of trades.

Keywords: Experimental Economics, Market Design, Oligopsony, Stochastic Pollution