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Title: Bilateral oligopoly in pollution permit markets: experimental evidence

item SCHNIER, KURT - University Of California
item DOYLE, MARTIN - Duke University
item Rigby Jr, James
item YATES, ANDREW - University Of North Carolina

Submitted to: Economic Inquiry
Publication Type: Peer Reviewed Journal
Publication Acceptance Date: 12/3/2013
Publication Date: 7/1/2014
Citation: Schnier, K., Doyle, M., Rigby Jr, J.R., Yates, A.J. 2014. Bilateral oligopoly in pollution permit markets: experimental evidence. Economic Inquiry. 52(3):1060-1079.

Interpretive Summary: Permit trading markets (e.g., “cap and trade”) are a useful mechanism for reducing pollution in a manner that spreads the costs efficiently across agents. In some cases these markets may have a relatively small number of participants. One example is the use of a permit trading market to control nitrogen concentrations in an estuary by permitting emissions from waste-water treatment plants. Markets with few buyers and few sellers such as these are termed “bilateral oligopolies” and have only recently received much attention from researchers wishing to understand the behavior of such markets. A key difference in the theoretical behavior of these small markets is the ability of participants to use strategic behavior to manipulate prices thereby reducing the efficiency of the market. While the theory of rational behavior within these markets has been explored, it is necessary to determine whether in practice participants will actually behave according to this theoretical model of rational behavior. This project offered the first experimental test of economic behavior in a bilateral oligopoly for comparison with theory and found that while behavior accords with theory generally there are significant departures in practice from theoretical behavior. This work will be important for designing pollution strategies at the watershed level where trading markets may be expected to have relatively few buyers and sellers.

Technical Abstract: We experimentally investigate behavior in a bilateral oligopoly using a supply function equilibria model (Klemper and Meyer 1989; Hendricks and McAfee 2010; Malueg and Yates 2009). We focus on the role that market size and the degree of firm heterogeneity have on the market equilibrium. Our results indicate that subjects within the experiment recognize the strategic incentives in a bilateral oligopoly, but they do not exploit these incentives to the exact magnitude predicted by theory. We find weaker support for predicted market outcomes, as market efficiency does not depend on market size, and in some cases buyers or sellers are more successful at extracting the rents from the market.