Allowing communities to trade in imperfectly competitive pollution-permit markets

Citizens and organizations representing them play an increasingly important role in markets for environmental quality, but much remains to be learned about how their participation affects these markets. We analyze the effects of allowing a community of citizens to trade pollution permits in an imperfectly competitive permit market. Allowing the community to trade directly reveals its preferences, which enhances welfare. However, community participation may also exacerbate distortions due to market power, even though the community itself trades competitively. Including the community in permit distribution may exacerbate market power distortions by affecting a dominant trader’s propensity to participate in the permit market. Second, the community’s demand/supply for permits may be more inelastic than other traders and worsen distortions due to market power. We illustrate in an example that these negative effects on competition can dominate the positive effect from preference revelation through the market place.