Choosing Winners and Losers in a Classroom Permit Trading Game.

• Author: Anderson, Lisa R.

Lisa R. Anderson [*]

Sarah L. Stafford [+]

This paper presents a classroom game in which students trade pollution permits. By changing the distribution of permits across firms, the game shows students how the allocation of property rights determines the winners and losers in the permit trading system but does not affect the efficiency of the system. This game can be used in a variety of classes, including principles or environmental economics, and can be conducted in a 50-minute class period with follow-up discussion in the next class.

1. Introduction

   In many economics classes, from principles to environmental economics and public finance, we teach students that tradable pollution permits are an efficient way to achieve the socially optimal level of pollution. This can be shown to students relatively easily using standard firm cost curves or simply by discussing how firms that can cheaply reduce their pollution can sell their rights to firms with higher pollution reduction costs. [1] It is often more difficult to convince students that for a fixed level of permits, the initial allocation of permits does not affect the efficiency of the trading program but only the distribution of the financial burden of reducing pollution. [2] Understanding the distributional effects of trading programs is important because equity issues are what make some trading programs controversial. For example, the initial allocation of permits is one of the contentious issues in developing an international tradable permit program for greenhouse gas emissions.

   To illustrate the distributional effects of a permit-trading program, we have developed a simple classroom game. This game can also be used more generally to show how the distribution of property rights determines who internalizes an externality but does not affect whether the social optimum is achieved. This game can be conducted in a 50-minute class with a short follow-up discussion in the next class period and requires only a deck of playing cards, index cards, and copies of the instructions and record sheets in the Appendix. [3]

2. Setting up the Permit Trading Market

   This game is designed for nine "firms" but can easily be expanded to accommodate more firms. [4] Firms may consist of one or more students, but we recommend no more than four students per firm to ensure that each student is involved in the decision-making process. Additionally, you will need two students to help run the game. Each firm can produce up to two units of a good that can be sold in a competitive market at a price of $12. The good costs nothing to produce, but production results in one unit of pollution per unit produced. [5]

   Distribute the instructions and record sheets (Table 1) to the students so they can keep up with transactions and earnings. [6] Each student should have a copy of the instructions, but you only need to distribute one record sheet per firm. Give each firm a number or name and have the students write the firm's identity on the record sheet. Read through Part 1 of the instructions. In the first period, there are no restrictions on pollution. Have each firm decide how much to produce. Since production is costless and the good can be sold for $12, each firm should produce two units of the good and therefore two units of pollution.

   In the second period, you announce that Congress is concerned with the level, of pollution from this industry and therefore the Environmental Protection Agency (EPA) has decided to regulate the level of pollution each firm emits (Part 2 from the instructions). Give each firm an index card, which represents a permit for one unit of pollution. Explain to the firms that they must have a permit for every ton of pollution that they emit. If the firm generates more pollution than they have permits, they must clean up the pollution. However, cleaning up pollution, also known as pollution abatement, is not costless. Each firm will have a different abatement cost depending on the technology that the firm employs and the age of its plant. To represent the cost of abatement, use the playing cards from two through ten, and give each firm one card.

   The cost of cleaning up one unit of pollution is the number on the playing card that they are given. In this period, do not let firms trade permits. The assistants can check record sheets to verify that firms abate one unit of pollution if they choose to produce two units of the good, since they have only one pollution permit to relinquish. Collect all pollution permits at the end of the period.

   In period three, redistribute the permits, one to each firm, and announce that they may buy and sell permits (Part 3 instructions). Explain that the trading will take place in a pit market setting. [7] Designate an area of the room for trades to take place. Each firm that wants to buy a permit should send a...