Cap-and-trade

Definition

Cap-and-trade is an environmental policy tool that regulates greenhouse gas emissions by setting a limit, or cap, on total emissions while allowing companies to buy and sell permits to emit CO2. This market-based approach incentivizes businesses to reduce their emissions as they can profit from selling excess allowances, promoting innovation and sustainability.

5 Must Know Facts For Your Next Test

1. The cap in cap-and-trade is usually reduced over time, leading to lower overall emissions as companies have to adapt to stricter limits.
2. Countries like the United States and members of the European Union have implemented cap-and-trade systems as part of their climate change mitigation strategies.
3. Cap-and-trade programs are often designed to be flexible, allowing businesses to find cost-effective ways to reduce emissions rather than following rigid regulations.
4. The revenue generated from selling emission permits can be used to fund renewable energy projects and other sustainability initiatives.
5. Cap-and-trade has been credited with successfully reducing emissions in several regions, proving that market mechanisms can be effective in addressing environmental challenges.

Review Questions

• How does cap-and-trade create economic incentives for companies to reduce their greenhouse gas emissions?
  • Cap-and-trade establishes a financial motive for companies by allowing them to buy and sell emission permits. If a company reduces its emissions below its allotted cap, it can sell its surplus permits to other companies that exceed their limits. This trading mechanism encourages businesses to innovate and invest in cleaner technologies to reduce their emissions and potentially profit from selling extra allowances.
• What are the potential advantages and disadvantages of implementing a cap-and-trade system for combating climate change?
  • The advantages of cap-and-trade include fostering economic flexibility, encouraging technological innovation, and generating revenue for environmental initiatives. However, disadvantages may include market volatility, the risk of permitting fraud, and the challenge of setting appropriate caps. Furthermore, if not designed carefully, it may disproportionately affect low-income communities who could bear higher energy costs.
• Evaluate the effectiveness of cap-and-trade programs in achieving substantial reductions in greenhouse gas emissions globally.
  • Cap-and-trade programs have shown varying degrees of effectiveness across different regions. In some cases, such as the European Union's Emissions Trading System, there have been significant reductions in emissions due to strict caps and robust enforcement mechanisms. However, challenges like permit oversupply and fluctuating prices have sometimes undermined these efforts. Ultimately, while cap-and-trade can be an effective tool in combating climate change when well-designed and implemented, it is not a standalone solution; it must be part of a comprehensive approach that includes other policies and regulations.

Related terms

Emissions Trading System (ETS): A system that allows companies to trade emission allowances, forming a market for carbon credits aimed at reducing overall greenhouse gas emissions.

Carbon Credits: Permits that allow the holder to emit a certain amount of carbon dioxide or other greenhouse gases, which can be traded in a cap-and-trade system.

Greenhouse Gases: Gases that trap heat in the atmosphere, contributing to climate change; the main ones include CO2, methane, and nitrous oxide.