Abstract: The market power has become a key problem to limit the extent to which emissions trading systems can fulfill their theoretical promises. Prior research has concentrated on market manipulation by firms seeking to minimize the compliance costs, and exclusionary manipulation within a particular sector under emissions trading system. However, the increasingly significant trends of industry segment and the characteristic of export-oriented economic development largely cause the absence of significant products competition in China's regional emissions trading system. In view of such conditions, the issue of market power in emission trading systems under heterogeneous product condition is mainly explored by taking the interaction between emissions trading system and product markets into account. As the research base, the socially optimal allocation condition is analyzed using a non-linear programming model firstly. Then, a Stackelberg game model between the dominant firm and the fringe firm is constructed in order to examine the strategic behavior of dominant firm and its impact on the system equilibrium by analyzing the optimal decision of fringe firm under specific permit price. The results show that market power has a diverse and complex influence on the system equilibrium. Especially, in order to obtain the windfall profit, the dominant firm would choose two price manipulation strategies:"premium-pricing" strategy while it acts as a permit seller and "under-pricing" strategy while it acts as a buyer. These strategies inevitably cause the deviation of system equilibrium from socially optimal state and the large profit loss of the fringe firm. Moreover, the initial endowment of emission permits is the crucial factor affecting the decision making of the dominant firm. Finally, a quantitative analysis is used to verify conclusions of the analysis, and demonstrates the impact of changes of pollutant producing coefficients of the dominant firm, abatement cost and so forth on the system equilibrium particularly.

Key words: emissions trading, market power, price manipulation, product heterogeneity, system equilibrium