Design of Tradable Permit Programs under Imprecise Measurement

Abstract

If the measurement of production in a commons is accurate and precise, it is possible to design a tradable permit program such that, under a fairly general set of conditions, the market equilibrium is efficient for the given aggregate permit level and everyone is better off after the permit program than before. Often, however, implementation of a tradable permit system is postponed or never undertaken because an inexpensive technology able to provide accurate and precise measurements does not exist. However, there often is an inexpensive technology which accurate but not precise. I study the possibilities for the design of a tradable permit system when the measurement technology involves an imprecise, indirect measure of production that contains statistical uncertainty. To the best of my knowledge, this has not been studied before. As one might expect, imprecise measurement can lead to inefficiency and prevent voluntary participation. But there are positive results. If measurement errors are proportional to use, it is possible to design so that aggregate output is efficiently allocated. Also, it is possible to calculate a set of individual firm lump-sum subsidies to attain voluntary participation.