The value of the market: Heterogeneity and gains from trade in permit and quota markets

Many quantity constraining policies are in place in market economies. Conditions for trade in these rights or obligations to produce can be politically sensitive policy choices. Benefits from trade, and so the value of the associated market, are determined by heterogeneity among potential traders. For a production quota setting with proportional reduction in production relative to an historic baseline, we compare tradable and non‐tradable implementations of the same aggregate constraint and investigate how heterogeneity among producer groups in initial production shares and/or supply elasticities affect the extent of gains from allowing trade in the quota. Given the demand elasticity and size of aggregate cut in production, the difference between the inverse of the share‐weighted harmonic mean and the arithmetic mean of elasticities is a summary statistic for the extent of gains from trade. Important determinants of gains are the variability in production elasticities among groups, as characterized by a mean‐preserving spread, and the covariance between production shares and group supply elasticities. Arguments are provided that this covariance should generally be negative, although a convex cost function with positive covariance is identified.