Decentralized economic incentives under technological indivisibilities: A cooperative game approach

Abatement technology is often characterized by indivisibility. In those instances, it is usually more efficient to operate the installed abatement device at full capacity in order to capture economies of scale. In these situations, efficiency may not necessarily be achieved by market incentive schemes such as taxes or tradeable permits. Installing a device may entail "too much" or "too little" investment in relation to the target level. A tax could entail higher cost than a command-and-control approach, while equilibrium in a permits market may not even exist. The paper proposes an alternative incentive scheme - the Fine Incentive Scheme (FIS) - which imposes a fine (penalty) if the given (area-wide, not firm-specific) emission (or ambient) standard is violated. The performance of the FIS is evaluated in a game-theoretic framework - specifically, a cooperative-game, analysis - since a measure of interdependence is introduced via the FIS. The model is illustrated with data from the Haifa area in Israel. These empirical results are contrasted with a non-cooperative framework, as well as with command and control (CAC) and the two "traditional" economic incentive schemes - taxes and permits. It is shown that taxes are the least-desired mechanism while tradeable permits often don't work. Furthermore, the efficacy of command and control relative to the FIS varies with the circumstances; the latter does not necessarily dominate the former under a rather wide range of circumstances.