A Dynamic Game of Technology Diffusion under an Emission Trading Regulation: A Pilot Experiment

In this paper we investigate how the interaction between the product and the emission permit markets may affect firms' propensity to adopt cleaner technologies. The adoption of a cleaner technology has the direct effect of reducing the compliance cost of the firm, but it also involves a strategic decision, if the industry is not perfectly competitive. We look at this problem from both a theoretical and an experimental point of view. We develop a model of duopoly, in which two firms engage in quantity competition in the output market and behave as price takers in the permit market. Firms have the possibility of investing in a cleaner production technology, which is available on the market at some cost. We set up a dynamic game over an infinite horizon in order to investigate firms' investment decisions: in each period, each firm decides whether to invest in the new technology or not. The stationary equilibria to this game crucially depend on both the cost of switching to the cleanest technology and the emission cap. Technology diffusion is one of the possible equilibria of the game. In order to test the predictions of the theory, we design and implement an "innovation experiment" that replicates the "innovation game". The results of our pilot experiment suggest that firms' behaviour will eventually lead to innovation diffusion.