PREEMPTION BY BASELINE

Abstract

The Clean Development Mechanism (CDM) is a project based mechanism introduced by the Kyoto protocol (1997). Among other unsettled issues pertaining to CDM, this paper explores a dynamic implication of CDM baseline. A continuous time dynamic duopoly model of an incumbent firm and an entrant firm is constructed. We show that CDM baseline plays an important role when the incumbent (leader) and the entrant (follower) choose their timing of CDM project investments. Because of the baseline, the entrant’s investment with higher technological potential gets postponed, while the incumbent invests earlier than otherwise.