Cap-and-Trade

Definition

Cap-and-trade is a market-based approach to controlling pollution by providing economic incentives for achieving reductions in the emissions of pollutants. It sets a limit (or cap) on the total amount of a specific pollutant that can be emitted, and then allows entities to trade emission allowances or credits among themselves.

5 Must Know Facts For Your Next Test

1. The cap in a cap-and-trade system is set by the government or a regulatory body and is reduced over time to achieve desired emission reduction targets.
2. Entities that emit less than their allocated allowances can sell their excess credits to those who emit more, creating a market for emission allowances.
3. Cap-and-trade systems provide flexibility for emitters to choose the most cost-effective way to reduce their emissions, whether through technological improvements, process changes, or purchasing additional credits.
4. The price of emission allowances is determined by the market, which reflects the supply and demand for the right to emit a certain amount of pollution.
5. Cap-and-trade systems have been implemented in various regions, such as the European Union's Emissions Trading System (EU ETS) and the Regional Greenhouse Gas Initiative (RGGI) in the northeastern United States.

Review Questions

• Explain how a cap-and-trade system works to control pollution.
  • In a cap-and-trade system, the government or a regulatory body sets a cap on the total amount of a specific pollutant that can be emitted. Entities, such as businesses or industries, are allocated a certain number of emission allowances, which represent the right to emit a certain amount of the pollutant. Entities that emit less than their allocated allowances can sell their excess credits to those who emit more, creating a market for emission allowances. The price of these allowances is determined by supply and demand, providing an economic incentive for entities to reduce their emissions in the most cost-effective way possible, whether through technological improvements, process changes, or purchasing additional credits.
• Discuss the advantages of a cap-and-trade system compared to traditional command-and-control regulations.
  • Compared to traditional command-and-control regulations, a cap-and-trade system offers several advantages. First, it provides flexibility for emitters to choose the most cost-effective way to reduce their emissions, allowing them to find the most efficient solutions. Second, the market-based approach to pricing emission allowances creates an economic incentive for entities to innovate and find ways to reduce their emissions, as they can profit from selling their excess credits. Third, the cap-and-trade system allows for a gradual and predictable reduction in emissions over time, as the government can lower the overall cap to achieve desired environmental targets. This flexibility and market-driven approach can lead to more cost-effective and innovative solutions for addressing pollution compared to rigid, one-size-fits-all regulations.
• Evaluate the role of cap-and-trade systems in addressing global environmental challenges, such as climate change.
  • Cap-and-trade systems have emerged as a key policy tool in addressing global environmental challenges, particularly climate change. By setting a cap on the total amount of greenhouse gas emissions, these systems create a market for carbon credits, providing a financial incentive for entities to reduce their emissions. This market-based approach encourages innovation, technological advancements, and cost-effective solutions for mitigating emissions. Moreover, the ability to gradually lower the emissions cap over time allows for a measured and predictable transition towards a low-carbon economy. However, the success of cap-and-trade systems in addressing global environmental challenges depends on factors such as the stringency of the emissions cap, the coverage of the system, and the effective enforcement of the regulations. Careful design and implementation of these systems, coupled with complementary policies, are crucial for cap-and-trade to play a significant role in tackling complex environmental issues like climate change.

Related terms

Emissions Trading:

A system where emitters can buy and sell emissions allowances, providing flexibility and cost-effectiveness in meeting environmental targets.

Carbon Pricing: A policy tool that puts a price on carbon emissions, either through a carbon tax or a cap-and-trade system, to incentivize emission reductions.

Pollution Externality: The uncompensated costs or benefits that an economic activity imposes on third parties, such as the environmental damage caused by pollution.