tradable pollution permits extra info

Question 1

how does tradable pollution permits work?

Answer 1

1. The government decided on the level of CO2 that the economy is allowed to emit in a year.
2. permits are issued to match this cap, so caps will be set to reach the socially optimum level assuming that the government will know the externalities
3. firms have to make decisions based on the least cost-
   option 1 they can invest in green tech and finds ways of producing that will be more climate friendly
   option 2 they can buy up the spare permits
4. if the government sets strong enforcement policies on these permits then pollution levels will decrease
5. when pollution goes down they will be able to reach the socially optimum level thus improving allocative efficiency- you can further elaborate and talk about how in long-run they can profit maximize and will not be burdened.

Question 2

how would the curve look like for tradable pollution permit?

Answer 2

label the x-axis as quanitity of permits
label the y-axis as price of permits
-draw a supply curve straight line to show that it is perfectly price inelastic because the level of permits have to match the cap it can’t fall/rise
draw a demand curve pointing downwards and draw a dotted line of price and quantity.