TEACHING TOOLS: A POLLUTION RIGHTS TRADING GAME

I. OVERVIEW The U.S. Environmental Protection Agency (EPA) in recent years has moved toward market-based incentives as an alternative to command-and-control measures to achieve pollution reduction. A limited pollution rights market has existed since 1976, but a higher level of activity is occurring in response to Title IV of the 1990 Clean Air Act Amendments (Field [1994]). Beginning in 1995, fossil fuel power plants nationwide have been forced to cut sulfur dioxide (SO2) emissions by 40% through market incentives provided by the EPA (Passell [1992] and Taylor [1992]). The goal is to allow the industry to choose least-cost emission reduction rather than using across-the-board mandates that limit emissions or require specific technology. A classroom game can be played that allows students to determine the best choice among alternatives for meeting a regulatory goal of reduced emissions. Acting as the managers of several disparate industries, students can compare the cost of pollution reduction to the cost of acquiring permits to pollute. The appeal of the game is that students often have trouble accepting the concept of pollution rights but have no trouble using market forces to allocate them efficiently. Incentive-based pollution allocations have been allowed by the EPA and state environmental regulators for years.(1) The most well-known and market-oriented example is the RECLAIM (Regional Clean Air Incentives Market) program in Southern California. The South Coast Air Quality Management District (AQMD) has operated a market for hydrocarbon and nitrogen oxide emissions since the beginning of 1994. Under the program, eligible industrial plants regulated by the AQMD are allocated a specific number of annual emission credits, each equivalent to one pound of pollution. The industrial plants are entitled to retain their credits, or sell them in return for finding a way to reduce their emissions to the allowable level. The credits may be purchased by other industrial plants to allow them to meet their emission limits without reducing emissions, or may be purchased by third parties, including environmental groups. The number of credits is scheduled to decline by 6%-8% each year for the next decade. II. MATERIALS NEEDED The classroom experiment operates in the same manner as the RECLAIM program, with several simplifications. The materials needed are a chart for each industry in the market to assist students in calculating the costs of alternative approaches,(2) certificates representing emission credits, and a regulator (usually the instructor) to control the number and initial distribution of credits. If the game is run through an auction market, the regulator must also run the auction. I prefer to allow a decentralized market among the classroom industries in order to emphasize that the choice of an efficient solution is made without direction or coercion. I find that it takes about 45 minutes to introduce the game and conduct several rounds of trading. The students then need a little time to complete their worksheets. This means discussion must be postponed until the next class period unless you have two-hour classes, as I do. I don't believe there would be a serious loss of continuity when conducting discussion after a break of a couple of days if students have completed their worksheets. III. INSTRUCTIONS FOR CONDUCTING POLLUTION RIGHTS TRADING GAME Begin by discussing with students the concepts of regulatory control over air emissions and differences between command-and-control and market-based incentive methods of regulating. The key ideas for the students to consider are the regulatory agency's goal of reducing polluting emissions and the companies' goal of minimizing the costs of any pollution reduction they are forced to make. The attractive feature of the tradable emission rights method, compared to command and control, is that both goals can be achieved at a lower opportunity cost to society. …