Tradable Pollution permits (Cap & trade)

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Created by
Toby Landes (GRK7)

Cards (10)

  • Tradable pollution permits

    Also known as cap and trade, an innovative policy aimed at battling pollution-based market failure
  • Tradable pollution permits
    • Elements of regulation but more market-friendly approach to bringing down pollution
    • Overcomes issues of blanket regulation where all firms have to find a way to bring down pollution
  • Countries with tradable pollution permit schemes
    • EU
    • South Korea
    • UK
  • How tradable pollution permits work
    • Government sets a pollution cap, the amount of CO2 emissions the economy is allowed to emit in a year
    • Government issues permits to firms, each permit equivalent to 1 ton of CO2
    • A market for permits is created with a vertical, perfectly price inelastic supply curve and a normal downward sloping demand curve
    • Firms can choose to either invest in green technology to reduce emissions or buy spare permits in the market, whichever is cheaper for them
  • Firms A and B
    • Firm A reduces emissions to 32 tons, investing in green technology
    • Firm B continues emitting 40 tons, buying spare permits from Firm A
  • The overall level of CO2 emissions is kept at the cap level
  • Tradable pollution permits

    • Polluter (firm) pays for the externality in the most efficient, cost-effective way
    • Promotes long-run incentives for firms to invest in green technology
  • Government tightens the pollution cap
    Supply curve of permits shifts left, increasing the price of permits
  • Firms that have invested in green technology are not burdened by rising permit prices, can profit from selling spare permits
  • Issues with tradable pollution permits
    • Enforcement and accurate emissions measurement may be difficult, especially in developing countries
    • Government may set the cap level incorrectly, too tight or too lax
    • Increased production costs for firms could lead to plant shutdowns, carbon leakage, or passing on costs to consumers
    • Difficulty in achieving international cooperation, as some countries may free-ride on the efforts of others