Tradeable Permits and Direct Regulation Flashcards
Carbon Trading
Carbon trading is a system of limiting carbon emissions through granting firms permits to emit a certain amount of carbon dioxide. The amount of permits is decided by the government, and then permits are given to firms depending on various criteria (such as how much output a firm produces).
With these permits, a firm can then buy and sell these permits in an open market. For example, if a firm wanted to emit more pollution, it could buy more permits. If it reduced its pollution emissions, it could sell its surplus permits on the market.
How can the government respond to externalities?
Two ways:
- the government can use command-and-control policy to regulate behaviour directly
- alternatively, it can implement market-based policies such as as taxes and subsidies to incentivise private decision makers to change their own behaviour.
Direct Regulation
Command-and-control regulation can come in the form of government-imposed standards, targets, process requirements or outright bans. Such measures can make certain behaviours either required or forbidden with the goal of addressing the externality. For example, the government may make it illegal for a company to dump certain chemicals in a river. By doing so, the government hopes to protect the environment or other companies or individuals that use the river that would otherwise suffer a negative impact.
Direct Regulation
Under specific conditions, an appropriately defined tradeable permit system can maximise the value received from the resource, given the sustainability constraint.
Tradable Permits
Tradable permits are a market-based approach allowing the government to limit negative externalities produced by a group of firms. To address the problem of negative externalities, governments may use a quota system to try and limit them. In a quota system, the negative externality is capped at a certain amount. In the example of pollution, the government may put a quota on the amount of pollution a factory can produce by issuing can produce by issuing tradable permits.
Permit
The right to produce a given amount of a negative externality (the right to emit a specific volume of a pollutant).
Quota
A restriction on the import of something to a specific quantity.
Tradable Permits
When pursuing this approach the government sets a limit or cap on the amount of pollutant that may be emitted. It then allocates emissions permits up to the specified limit among firms. The permit represents the right to emit or discharge a specific amount of pollutant. Firms are required to hold a number of permits equal to their emissions. Firms that need to increase their volumes of emissions must buy permits that require fewer of them.
In effect, the buyer is paying a charge for polluting, while the seller is rewarded for having reduced emissions. The outcome achieved by the market for permits is more efficient, regardless of the initial allocation of permits.
The market for tradable permits
The market for tradable permits creates incentives for firms to produce less pollution. Firms that have a high cost of reducing emissions are willing to pay for the permits, while those that can reduce emissions in the most cost-efficient manner will do so and sell their permits. Tradable permits thus achieve a desired level of the externality by allowing the market to determine which market actors can create the externality.
Logic behind the market for tradable permits
In a perfectly competitive market, permits will flow toward their highest valued use. Those that would receive lower value from using the permits (due to higher costs, for example) have an incentive to trade them to someone who would value them more. The trade benefits both parties: the seller reaps more from the sale than they could from using the permit, and the buyer gets more value from the permit than he pays for it. Supply for permits is always constant
