Consider the transaction costs model of section 8.4. Show that a unilateral increase in the seller’s transaction costs (increasing α₁) induces the permit price to decrease, while a unilateral increase in the buyer’s transaction costs (increasing α₂) induces that price to increase. Show also that the sign effect on emissions is the same as in the case of a uniform marginal transaction cost increase.

Data from section 8.4

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Our discussion thus far has abstracted from the fact that permit trading can involve transaction costs, which may introduce frictions into a cap and trade system. Stavins (1995) was the first to offer a detailed analysis of how transaction costs impact the efficiency of permit trading schemes. He identifies three potential sources of transactions costs: (a) search and information; (b) bargaining and decision; and (c) monitoring and enforcement. Most of these costs arise at the beginning of a new emissions trading program. As the program matures, brokers will offer their services and transaction costs will fall considerably. Bargaining costs typically arise in thin markets, where the absence of a robust market means trades involve bilateral agreements rather than bids and offers submitted to an exchange