• Environmental and Resource Economics Review
• /
• v.33 no.2
• /
• pp.179-201
• /
• 2024

In introducing emissions trading schemes, many countries start with a high level of free allocation to reduce the sudden cost burden on companies and increase acceptance of the policy. The free allocation is then gradually reduced, considering the risks of carbon leakage. This aligns with the "polluter pays" principle and is often considered one of the elements of an advanced emissions trading scheme. In this context, this study uses a simple emissions trading market model to show that decreasing the free allocation rate may not be desirable if the emissions market is not perfectly competitive. In particular, by identifying the existence of a free allocation rate at which the cost inefficiency is minimized, this study demonstrates that having a low level of free allocation does not necessarily imply the improvement of the emissions trading scheme.