Pollution abatement using cap-and-trade in a dynamic supply chainand its coordination

We study a two-period supply chain consisting of a manufacturer, who participates in a cap-and-trade scheme and faces an uncertain emission permit price, and a retailer, who sells theproduct from the manufacturer to consumer and faces a price-sensitive demand. In the face ofuncertain future permit prices, the manufacturer determines the wholesale price and pollutionabatement in each period that reduces pollutants per unit of output one period later. We modelthe problem as a two-period Stackelberg game, obtain a feedback Stackelberg equilibrium, andinvestigate the effects of emissions trading on the manufacturer's abatement investment, supplychain performance, and social welfare. We obtain a revenue-and-cost-sharing contract thatcoordinates the dynamic stochastic supply chain. We show that the abatement level increasesin the permit price and decreases in its uncertainty. Moreover, the dirtier the supply chainis, the less is the effect of permit price and the more is the effect of its uncertainty. Boththe manufacturer and the channel may benefit from the permit price uncertainty. For a dirtysupply chain, a lower price and higher uncertainty intensify the double marginalization effect.If the second-period sales revenue is low enough, the manufacturer benefits and the retailerloses under the coordinating contract. Finally, when the toxicity of pollutants is relatively low(high), the effect of emissions trading on social welfare might be stronger in a cleaner (dirtier)supply chain.