Cap-and-trade

Definition

Cap-and-trade is an environmental policy tool that sets a limit (cap) on the total amount of greenhouse gases that can be emitted by certain sectors. Companies are allocated or can buy emission allowances that permit them to emit a specific amount of pollutants, and they can trade these allowances among themselves, encouraging cost-effective reductions in emissions while promoting economic flexibility.

5 Must Know Facts For Your Next Test

1. Cap-and-trade systems can help reduce overall emissions in a cost-effective way by allowing businesses with lower costs of reducing emissions to sell their extra allowances to those with higher costs.
2. The cap is usually reduced over time, meaning that fewer allowances are available each year, which helps to gradually decrease total emissions.
3. Cap-and-trade has been implemented in various regions, including the European Union Emission Trading System (EU ETS) and California's Cap-and-Trade Program.
4. The effectiveness of cap-and-trade systems depends on stringent monitoring, reporting, and verification processes to ensure compliance and prevent fraud.
5. Critics argue that cap-and-trade may allow companies to continue polluting by purchasing allowances instead of making substantial changes to reduce emissions.

Review Questions

• How does cap-and-trade serve as a government solution to externalities, particularly in terms of reducing greenhouse gas emissions?
  • Cap-and-trade functions as a government solution to externalities by placing a limit on total greenhouse gas emissions while providing economic incentives for companies to reduce their emissions. By creating a market for emission allowances, it encourages businesses to innovate and find cost-effective ways to cut down on pollution. This system not only helps in addressing the negative externality of climate change but also promotes economic efficiency by allowing the trading of allowances among firms.
• Discuss the potential advantages and disadvantages of implementing a cap-and-trade system compared to direct regulation in addressing environmental externalities.
  • One advantage of cap-and-trade over direct regulation is its flexibility; companies can choose how they meet their emissions targets, either by reducing emissions or purchasing allowances. This can lead to lower overall costs for achieving emission reductions. However, disadvantages include the complexity of setting up the system and the need for robust monitoring and enforcement mechanisms. Additionally, there's a risk that companies might exploit loopholes, leading to ineffective pollution control if not properly regulated.
• Evaluate how international cooperation through cap-and-trade systems could impact global efforts to combat climate change.
  • International cooperation in cap-and-trade systems could significantly enhance global efforts against climate change by creating a unified approach to emissions reductions. If countries establish linked cap-and-trade markets, it can lead to more efficient allocation of resources and technology transfer among nations. However, challenges arise from differing national interests, levels of economic development, and regulatory frameworks. Successfully aligning these differences requires diplomacy and commitment to shared goals, which could ultimately strengthen global environmental policies.

Related terms

Emission Allowance: A permit that allows the holder to emit a certain amount of greenhouse gases, typically measured in metric tons of CO2 or its equivalent.

Carbon Market: A marketplace where carbon credits and allowances are bought and sold, facilitating the trading of emissions reductions between entities.

Greenhouse Gases (GHGs): Gases such as carbon dioxide (CO2), methane (CH4), and nitrous oxide (N2O) that trap heat in the atmosphere and contribute to climate change.