Emissions Trading

Definition

Emissions trading, also known as 'cap-and-trade', is a market-based approach to controlling pollution by providing economic incentives for achieving reductions in the emissions of various pollutants. It allows companies or countries that can reduce emissions cheaply to sell their extra allowances to those that would face higher costs to meet their own emission targets.

5 Must Know Facts For Your Next Test

1. Emissions trading creates a market for pollution, allowing companies to buy and sell the right to emit a certain amount of a pollutant.
2. The 'cap' in a cap-and-trade system sets a limit on the total amount of emissions allowed, creating scarcity and driving up the price of emission allowances.
3. Emissions trading provides a financial incentive for companies to invest in cleaner technologies and reduce their emissions, as they can sell any extra allowances they don't need.
4. Emissions trading systems have been implemented in various regions, including the European Union's Emissions Trading System (EU ETS) and California's Cap-and-Trade Program.
5. The Polluter Pays Principle is a key justification for emissions trading, as it holds polluters accountable for the costs of their emissions.

Review Questions

• Explain how emissions trading works as a market-oriented environmental tool.
  • Emissions trading, or cap-and-trade, is a market-based approach to controlling pollution. It works by setting a cap on the total amount of a pollutant that can be emitted, and then issuing a limited number of emission allowances within that cap. Companies can buy and sell these allowances on the open market, providing a financial incentive to reduce emissions. Companies that can reduce emissions cheaply can sell their extra allowances to those that would face higher costs to meet their own targets. This creates a market for pollution and drives investment in cleaner technologies.
• Describe the role of the Polluter Pays Principle in the context of emissions trading.
  • The Polluter Pays Principle is a key justification for emissions trading systems. This principle holds that those who produce pollution should bear the costs of managing it to prevent damage to human health or the environment. Emissions trading implements this principle by requiring companies to hold emission allowances, which they must purchase or acquire through trading. This ensures that the costs of pollution are borne by the polluters themselves, rather than being externalized onto society or the environment. The market-based nature of emissions trading also provides a more efficient and cost-effective way to achieve environmental goals compared to traditional command-and-control regulations.
• Analyze how emissions trading systems, such as the EU ETS and California's Cap-and-Trade Program, have been implemented to address environmental challenges.
  • Emissions trading systems like the EU ETS and California's Cap-and-Trade Program have been implemented as market-oriented tools to address environmental challenges, particularly the reduction of greenhouse gas emissions. These systems set a cap on the total amount of emissions allowed, and then distribute or auction off a limited number of emission allowances. Companies must hold enough allowances to cover their emissions, creating a financial incentive to invest in clean technologies and reduce their pollution. The trading of these allowances on the open market allows the market to determine the most cost-effective ways to achieve emissions reductions. The implementation of these systems has been a key policy response to the urgent need to mitigate climate change, as they harness the power of the market to drive environmental improvements in a more efficient manner than traditional regulatory approaches.

Related terms

Cap-and-Trade:

A system where a limit (cap) is set on the total amount of certain pollutants that can be emitted, and companies are issued a number of emission allowances within that cap. Companies can then trade these allowances on the open market.

Carbon Pricing: The practice of putting a price on the emission of carbon dioxide and other greenhouse gases, either through a carbon tax or an emissions trading system, in order to incentivize reductions in emissions.

Polluter Pays Principle: The principle that those who produce pollution should bear the costs of managing it to prevent damage to human health or the environment.