Cap-and-trade system

Definition

A cap-and-trade system is an environmental policy tool that allows companies to buy and sell allowances for emissions, creating a market for pollution rights. The system sets a total cap on greenhouse gas emissions and distributes permits to emitters, incentivizing them to reduce emissions by trading unused allowances, thereby promoting cost-effective reductions in pollution levels.

5 Must Know Facts For Your Next Test

1. The cap-and-trade system originated from the Clean Air Act amendments in the United States in the early 1990s, primarily focusing on sulfur dioxide emissions.
2. Under this system, companies that can reduce their emissions at a lower cost can sell their excess allowances to companies facing higher costs, thus encouraging efficiency in emissions reductions.
3. Cap-and-trade has been implemented in various regions worldwide, including the European Union Emission Trading Scheme (EU ETS) and California's cap-and-trade program.
4. The total cap is gradually lowered over time to ensure that overall emissions decrease, aligning with climate goals and agreements.
5. Critics argue that cap-and-trade systems can lead to market manipulation and may not achieve the desired emissions reductions if not properly regulated.

Review Questions

• How does the cap-and-trade system create economic incentives for companies to reduce greenhouse gas emissions?
  • The cap-and-trade system incentivizes companies to reduce greenhouse gas emissions by allowing them to trade emission allowances. Companies that can lower their emissions at a lower cost can sell their extra allowances to those facing higher reduction costs. This market-based approach encourages innovation and efficiency, as firms look for the most cost-effective ways to comply with regulatory caps, ultimately leading to overall reductions in pollution.
• Discuss the potential advantages and disadvantages of implementing a cap-and-trade system for controlling greenhouse gas emissions.
  • One advantage of a cap-and-trade system is its flexibility; companies can choose how to meet their emission targets, either by reducing emissions or purchasing allowances. This can lead to cost savings and innovation. However, disadvantages include the risk of market manipulation and the difficulty in setting an appropriate cap that reflects scientific recommendations. Additionally, if allowances are allocated for free instead of auctioned, it may reduce the financial incentive for companies to invest in greener technologies.
• Evaluate the effectiveness of cap-and-trade systems in achieving long-term climate goals compared to other regulatory approaches.
  • Evaluating the effectiveness of cap-and-trade systems reveals mixed results when compared to other regulatory approaches like direct regulations or carbon taxes. While cap-and-trade encourages market-driven solutions and innovation, its success largely depends on stringent caps and proper enforcement mechanisms. In some cases, cap-and-trade has led to significant reductions in emissions, but it can also fall short if loopholes exist or if allowances are issued too leniently. Therefore, its long-term effectiveness is contingent upon ongoing adjustments and a combination with complementary policies that ensure overall climate goals are met.

Related terms

Emissions Trading: A market-based approach to controlling pollution by providing economic incentives for reducing emissions of pollutants.

Carbon Credit: A permit that allows the holder to emit one ton of carbon dioxide or an equivalent amount of a different greenhouse gas, which can be traded in the cap-and-trade market.

Greenhouse Gas Inventory: A comprehensive accounting of all greenhouse gases emitted by a specific entity, used to assess and manage emissions reductions.