Emission Trading System

Definition

An emission trading system (ETS) is a market-based approach to controlling pollution by providing economic incentives for reducing emissions of pollutants. It allows companies to buy and sell allowances for their emissions, creating a financial incentive to lower their output of harmful gases. This system is crucial for meeting regulatory requirements under environmental laws like the Clean Air Act, which aims to improve air quality by capping overall emissions and allowing flexibility in how reductions are achieved.

5 Must Know Facts For Your Next Test

1. The Clean Air Act established the legal framework for the emission trading system, particularly through provisions aimed at controlling sulfur dioxide and nitrogen oxides emissions from power plants.
2. Under an ETS, companies that reduce their emissions below their allowance can sell their excess allowances to other companies that are struggling to meet their limits.
3. Emission trading systems encourage innovation by allowing firms to find cost-effective ways to reduce emissions rather than relying solely on regulatory compliance measures.
4. The success of an ETS can be evaluated through its ability to achieve emission reduction targets while minimizing economic costs.
5. ETSs have been adopted in various regions around the world, including the European Union and California, demonstrating different approaches and results in managing air quality.

Review Questions

• How does an emission trading system create economic incentives for companies to reduce their emissions?
  • An emission trading system creates economic incentives by allowing companies to buy and sell emission allowances. If a company reduces its emissions below its allowance, it can sell its extra permits to another company that may be over its limit. This market dynamic encourages companies to find cost-effective ways to cut emissions because they can profit from selling surplus allowances instead of facing penalties for exceeding limits.
• Discuss the role of the Clean Air Act in establishing emission trading systems and their importance in regulating air quality.
  • The Clean Air Act plays a critical role in establishing emission trading systems by providing the legal framework needed to cap emissions of pollutants like sulfur dioxide and nitrogen oxides. By setting enforceable limits on these harmful emissions, the Act enables the creation of a market for trading allowances, incentivizing companies to innovate and find ways to reduce their emissions efficiently. This approach helps achieve regulatory goals while maintaining economic flexibility for businesses.
• Evaluate the effectiveness of emission trading systems in achieving air quality improvements compared to traditional regulatory approaches.
  • Emission trading systems have been shown to be effective in achieving air quality improvements while offering economic flexibility compared to traditional regulatory approaches. By allowing companies to trade allowances, ETSs enable targeted reductions where they are most cost-effective, often leading to greater overall compliance at lower costs. However, their success also depends on proper design, enforcement mechanisms, and market stability. In cases like the U.S. Acid Rain Program, significant reductions in sulfur dioxide emissions were achieved at a fraction of the cost anticipated by traditional regulations.

Related terms

Cap-and-Trade: A specific type of emission trading system where a limit (cap) is set on total emissions, and companies can trade allowances within that limit.

Carbon Credits: Permits that represent the right to emit a certain amount of carbon dioxide or equivalent greenhouse gases, often used in carbon markets.

Greenhouse Gases: Gases that trap heat in the atmosphere, including carbon dioxide, methane, and nitrous oxide, which are targeted for reduction in emission trading systems.