Tradable permits and production-inventory strategies of the firm

The paper deals with the effect of introduction of tradable permits on the production-inventory strategy of a firm. The basic model of Arrow and Karlin [1958. Production over time with increasing marginal costs. In: Arrow, K.J., Karlin, S., Scarf, H. (Eds.), Studies in the Mathematical Theory of Inventory and Production. Stanford University Press, Stanford, pp. 61-69] assumes that the firm minimizes the sum of linear holding and convex production costs. These costs depend explicitly on time. After introducing emission trading, the cost function will contain linear emission procurement/selling cost. We compare two optimal production-inventory strategies of a firm to examine changes of optimal strategies. The first strategy is the optimal solution of the Arrow-Karlin model. Then we analyze this model extended with costs of tradable permits. (C) 2007 Elsevier B.V. All rights reserved.