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Auctioning in the Emissions Trading System

In light of recent political decisions and scientific reports, global climate change has become one of the most pressing issues in the news. Scientists warn that countries will have to take “unprecedented actions” over the next decade to avoid warming that will have devastating effects on the planet. One policy that has achieved significant success in reducing emissions is the European Union Emissions Trading System (EU ETS). Under this policy, there is a cap to how much greenhouse gases participating countries can emit. Within that cap, they can trade “international carbon credits” as needed, through auctioning. European countries typically find themselves purchasing credits from developing countries, however, because reducing emissions is less costly to do so in these places, and because this generates income for their governments.

I propose that the auctioning mechanism for the ETS should be the first price auction. In this class, we have learned that in a first price auction, the winning bidder plays exactly their bid. This way, developing countries would get properly compensated for reducing emissions on behalf of the EU. If European countries operated under a second price auction, the carbon credits would be sold for less than they are worth to a particular country in the EU. The country with the winning bid will pay the second highest bid for the carbon credit, and therefore, pay less than what they believe the credit is actually worth. Under a first price auction, however, the country will pay exactly what they bid (even if it is shaded slightly downward) which will most likely be closer to their true value than the second highest bid. In the end, developing countries will receive the proper monetary compensation for contributing to the fight against climate change.


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October 2018