Cap and trade

Definition

Cap and trade is an environmental policy tool designed to reduce greenhouse gas emissions by setting a limit or 'cap' on total emissions allowed within a specified timeframe. Companies are given allowances that permit them to emit a certain amount of pollutants, and they can buy or sell these allowances in a trading system, incentivizing them to lower their emissions while maintaining economic flexibility.

5 Must Know Facts For Your Next Test

1. Cap and trade systems aim to reduce emissions cost-effectively by allowing companies that can lower emissions easily to sell their excess allowances to those facing higher costs.
2. The overall cap on emissions is usually reduced over time, promoting continual improvements in emissions reductions across industries.
3. Many countries and regions have implemented cap and trade programs, including the European Union Emissions Trading System (EU ETS) and California's Cap-and-Trade Program.
4. Cap and trade can help drive innovation as companies seek out new technologies and methods to lower their emissions to save costs on allowances.
5. Critics argue that cap and trade can lead to market manipulation or inequities if not carefully regulated, as companies may prioritize buying allowances over actual emission reductions.

Review Questions

• How does the cap and trade system incentivize companies to reduce their greenhouse gas emissions?
  • The cap and trade system creates a financial incentive for companies to reduce their greenhouse gas emissions by allowing them to buy and sell emissions allowances. If a company reduces its emissions below its allowance, it can sell its excess allowances to other companies that need them. This creates a market for emissions reductions, encouraging innovation and investment in cleaner technologies while maintaining economic efficiency.
• Evaluate the effectiveness of cap and trade compared to other methods of regulating greenhouse gas emissions.
  • Cap and trade is often seen as more flexible compared to direct regulations because it allows companies the choice of how to meet their emissions targets. Unlike command-and-control approaches that impose strict limits, cap and trade encourages cost-effective reductions by enabling firms to find the cheapest way to cut emissions. However, its effectiveness depends on the design of the program, including how stringent the caps are set and how well the market is monitored for fraud or manipulation.
• Assess the potential long-term impacts of widespread adoption of cap and trade systems on global efforts to combat climate change.
  • The widespread adoption of cap and trade systems could significantly bolster global efforts against climate change by establishing a price on carbon, thereby internalizing the environmental costs associated with greenhouse gas emissions. As more countries implement such systems, it could lead to a harmonization of climate policies, fostering international cooperation. However, for this impact to be maximized, it will be crucial to ensure that these systems are linked effectively across borders and supported by robust regulatory frameworks that promote genuine emission reductions rather than mere trading activities.

Related terms

Greenhouse Gas Emissions: Gases that trap heat in the atmosphere, contributing to climate change, including carbon dioxide (CO2), methane (CH4), and nitrous oxide (N2O).

Emissions Allowance: A permit that allows the holder to emit a specific amount of greenhouse gases; these can be traded in a cap and trade system.

Carbon Credit: A certificate representing the right to emit one metric ton of carbon dioxide or an equivalent amount of another greenhouse gas; can be bought and sold on carbon markets.