The regulatory strategy in emissions trading system under costly enforcement

Abstract

In a two-stage dynamic game of regulator and polluting firms, the optimal regulatory strategy to achieve a fixed aggregate emissions target cost-effectively in emissions trading system was studied under the context of costly monitoring and sanctioning, including the monitoring level, the aggregate supply of permits, and the penalty shape for noncompliance. Based on gaming analysis, a heterogeneous agent-based experiment platform for regional emissions trading system was established using computational experiment. Then further analyses were done from perspectives of dynamic and bounded rationality. The results show that the optimal strategy to achieve target is to induce full compliance. This is not simply setting severe punishment, but seeking tradeoff between the level of monitoring and punishment. Finally, integrating the permit price directly into the penalty shape allows the policy objective to be achieved more cost-effective.