Prices vs. Quantities: Environmental Regulation and Imperfect Competition.

In a market subject to environmental regulation, a firm's strategic behavior affects the production and emissions decisions of all firms. If firms are regulated by a Pigouvian tax, changing emissions will not affect the marginal cost of polluting. However, under a tradable permits system, the polluters' decisions affect the permit price. This paper shows that this feedback effect may increase a strategic firm's output. Relative to a tax, tradable permits improve welfare in a market with imperfect competition.

Mansur, Erin. "Prices vs. Quantities: Environmental Regulation and Imperfect Competition". NBER Working Paper No. 13510. Oct 2007.