3. What is cap and trade?
There are many reasons as to why climate change is occurring, caused by an increase in CO2, as
a result of either over consumption or over production.
The reason for this externality is that the price of either consumption or production of a good
does not account for either the social cost or social benefit.
In otherwords A negative externality arises where MSC>MPC or MSB>MPB
There are now several plans for reducing greenhouse gas emissions bouncing around the
political landscape. ...
1. Cap-and-trade:
Emissions trading is a market-based approach to controlling pollution by providing economic
incentives for reducing the emissions of pollutants.
A government authority establishes a ‘çap’ that limits the total amount of GHG’s allowed.
4. How it works
To achieve a reduction on carbon emissions the government needs to set a carbon cap
(limit) by issuing carbon permits to polluting firms.
This can be done by issuing each firm the same amount of permits
This is represented by the vertical "cap" line S*.
The abatement cost to the low abatement cost firm is equal to area C.
The abatement cost to the high abatement cost firm is D + F + G + K.
The permit gives the emitter the right to pollute the global atmosphere.
with the total amount of allowances limited by the cap
5. These permits can then be traded as ‘private property’
The amount of greenhouse gasses will decrease each year, creating a demand for a new commodity,
‘carbon permits’.
Theses trades create a market price for greenhouse gasses.
When offered a high enough return (or faced with higher costs), polluters that own permits (or
needed permits), will reduce their emissions.
Each firm can design its own compliance strategy to meet the overall reduction requirement which
may include:
– the sale or purchase of allowances,
– installation of pollution controls,
– implementation of efficiency measures,
6.
7. 1. Cap-and-trade example:
Suppose that the government restricts emissions to
a level consistent with Q1.
The new supply curve - denoted by S* - is now
vertical at the target: no matter how high the price
goes, supply will remain fixed at Q1.
The new equilibrium is again B: the quantity is
determined by the cap at Q1, and the price will rise
to P1.
The cap is where marginal benefit equals marginal
abatement cost -- represented by the vertical "cap"
line S*. The polluting firm must abate its carbon
emissions to Q1.
8. What is carbon tax and how does it work?
2. CARBON TAX
A carbon tax is a tax levied on the carbon emissions required to produce goods and services.
Carbon taxes are intended to make visible the "hidden" social costs of carbon emissions, which
are otherwise felt only in indirect ways like more severe weather events
Under a carbon tax, the government sets a price that emitters must pay for each ton of
greenhouse gas emissions they emit.
Businesses and consumers will take steps, such as switching fuels or adopting new technologies,
to reduce their emissions to avoid paying the tax.
9. What is a Carbon Tax?
If external cost can be identified and measured, a tax can be
levied on the responsible party.
Suppose that a carbon tax is added into the price.
For a given quantity, the supplier's price will be the old price plus the
amount of the tax, and the supply curve will shift up to S*.
The new equilibrium is at point B, the quantity is the target Q1, and
the price will increase to P1.
After the tax, private cost will match social cost, so a more
efficient allocation of resources arises - higher price and lower
output
10. COMAND AND CONTROLLING EXTERNALITIES:
Command and control techniques:
Command and control policies involve the government applying legislation to regulate the use of the environmen
impose environmental standards on industries and even ban the use of certain pollutants:
Output quotas for producing and fines for exceeding pollution – licensing fishing (assigning property rights).
Outright prohibition of production that generates pollution.
Subsidies – use of subs to encourage fires to install pollution control equipment.
However, this appears to be paying firms to correct something it should not be doing in the first place. May
encourage firms to pollute.
Legislations: Environmental Protection Acts – E.g. Banning of certain products.
Command and Control – An Evaluation.
Regulation involves costs:
Costs of monitoring legislation
Costs of assessing the damages caused by externalities
Costs in bringing up individual cases to court and chasing up non-payment of fines!
Regulations have imperfect information
There are problems in assigning monetary values to externalities created
Danger that regulations might act more in the interests of producers rather than consumers.
The market mechanism might be a better means of achieving the desired reduction in externalities.
11. Coase Theorem
Coase theorem: whoever has property rights, can seek compensation.
Government intervention is not always required to handle externalities.
The free market can still achieve a socially efficient allocation of resources if the affected
parties can negotiate.
This is the basis of the Coase Theorem (Ronald Coase, 1960).
The Coase Theorem states that under ideal economic conditions, where there is a conflict of
property rights, the involved parties can bargain or negotiate terms that will accurately reflect
the full costs and underlying values of the property rights at issue, resulting in the most efficient
outcome.
Pareto efficiency -situation where no individual can be better off without making an individual
worse off.
12. Example
Consider a steel factory and a fishing club using a river.
The steel factory uses the river for its waste products while the fishing club uses the stream to
catch fish.
The factory imposes a negative externality on the fishing club by polluting the river and killing the
fish population.
This problem could be resolved by allocating the property rights of the river to the fishing club.
The factory would then have to negotiate or pay the fishing club for the right to use the river.
Either the factory could pay to clean its wastes before dischargingthem into the river or pay the
fishing club a fee which then could be used to install filters to purify the water.
The negative externality could be eliminated.
Alternatively the property rights to the river could be awarded to the factory and the fishing club
would then have to pay the factory to clean its wastes.
13.
14. What can the government do to
eliminate a market failure?
The government can provide information where this is lacking.
For those goods which are merit or demerit goods, and for which there is inadequate
information, the government can provide this information to bridge the gap.
As an alternative, the government could make a regulation which requires the firm to
set out certain information.
some examples of products and services which you can buy, and about which by law the
seller has to publish information about:
Financial products such as loans
Ready-prepared food – dietary information
Cigarettes
15. The diagram shows how, following provision of
information by the government, demand for a merit
good shifts right.
At the original equilibrium point A, the good is
underconsumed (Q1) and undervalued (P1).
Provision of information makes consumers more aware
of the benefits of the product.
This is shown by the shift in the demand curve from D1
to D2.
At the new equilibrium point B, both the quantity (Q2)
consumed and the price (P2) of the good have
increased, reflecting its value to consumers more
closely.
