Tax Policy in a Simple General Oligopoly Equilibrium Model with Pollution Permits

We introduce a pollution permits market in a general oligopoly equilibrium model. Specifically, we consider a two-commodity economy with one productive sector. The first commodity is inelastically supplied by a set of competitive traders. The second commodity is produced by a set of strategic traders, using the first commodity as an input. The production of the second commodity is a polluting activity. Introducing a competitive emissions permits market solves the pollution control problem but is not sufficient to eliminate market distortions and to reach a Pareto optimal allocation. We study the conditions under which a subsidy to the strategic agents, financed by a tax on the competitive agents, is welfare increasing.