Market-based environmental policy tools such as cap-and-trade, carbon taxes, and pollution permits.
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- What is the basic mechanism of a cap-and-trade system?
- A limit (cap) is set on total emissions, emissions permits are issued equal to the cap, and firms can trade permits, creating a market price for pollution.
- What are pollution permits in a cap-and-trade system?
- Property rights that allow the holder to emit one unit of a pollutant; they are tradable commodities in a market.
- What is permit banking in cap-and-trade?
- The practice of saving unused permits for future use, allowing firms to carry their allowances to later periods.
- Define a carbon tax.
- A tax levied on the carbon content of fossil fuels or directly on carbon dioxide emissions to internalize the external cost of climate change.
- How does a carbon tax affect firm behavior?
- Firms reduce emissions because emitting becomes more costly, and they can lower costs by investing in cleaner technologies or reducing output.
- What is the Coase Theorem?
- When transaction costs are zero and property rights are well-defined, the allocation of resources is efficient regardless of the initial distribution of those rights.
- What is a negative externality in environmental policy?
- A cost imposed on third parties who did not choose to incur it, such as pollution damage to the health and property of nearby residents.
- What is a market failure in environmental markets?
- A situation where the free market does not allocate resources efficiently because the polluter does not bear the full cost of pollution.
- Why does a carbon tax set a price floor for emissions reductions?
- The tax rate acts as a price floor; firms reduce emissions until the cost of abatement equals the tax rate, at which point they are indifferent between paying or reducing.
- What is the European Union Emissions Trading System (EU ETS)?
- The world's largest cap-and-trade system, covering power plants, manufacturing, and aviation in EU member states to reduce greenhouse gas emissions by set percentages.
- What are the Kyoto Protocol's market-based mechanisms?
- Emissions trading between countries, the Clean Development Mechanism allowing developed countries to fund emissions reductions in developing countries, and Joint Implementation between developed countries.
- What is the Regional Greenhouse Gas Initiative (RGGI)?
- A cap-and-trade system covering power plants in nine U.S. northeast and mid-Atlantic states, one of the first mandatory carbon markets in North America.
- Why does cap-and-trade achieve emissions reductions at least cost?
- The permit market ensures that each unit of emissions reduction is made by the firm that can do it most cheaply, so total abatement cost is minimized.
- Why is a carbon tax said to achieve efficiency?
- When the tax rate equals the marginal external cost of emissions, firms reduce emissions up to the point where marginal abatement cost equals the tax, achieving allocative efficiency.
- What revenue advantage does a carbon tax have over cap-and-trade?
- A carbon tax generates government revenue from the tax collections, while cap-and-trade only generates revenue if permits are auctioned rather than given away for free.
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