Supply-side management of CO2 emissions in a competitive market

This paper aims to design a programme for managing CO2 emissions in the electricity supply industry. Managing emissions, though a control problem, is much different from controlling mechanical or physical systems. The subject matter is a collection of firms, each of which behaves purposefully and competitively in seeking its own objectives. Emissions, a by-product, are outside of firms’ business concerns, and represent externalities. An effective instrument for controlling the externalities is a pricing mechanism that induces firms to act in line with the global objective. This instrument works when the competitors are driven by profit seeking incentive. The paper presents a model and algorithm for the regulator to price emissions and grandfather allowances.