Tradable Pollution Permits

Tradable Pollution Permits content slideshow. Designed for the Economic A level qualification. Can be used in revision and in class.

Subtopics
Intro and Analysis of Tradable Pollution Permits
Pros and Cons of Tradable Pollution Permits

1. Tradable Pollution Permits (Cap & Trade) Lower 6 th Micro Government Intervention

2. Intro and Analysis of Tradable Pollution Permits Tradable Pollution Permits Mr O’Grady

3. Tradable Pollution Permits Definition: legal allowances for firm to pollute up to a certain level each year Firms exceeding their permitted level can face heavy fines The government sets the total level of pollution permitted to correspond with the level of pollution expected at the socially optimal level of production Firms must therefore cut their output (towards QSO), or improve their production processes (increase the quantity which QSO occurs) Combats negative production externalities The importance of tradability: The ability to trade permits gives each polluter has flexibility to choose whether to cut pollution (through cutting output or investing in greener production) or to buy more permits Firms can therefore choose what is most cost efficient to them, improving efficiency If firms couldn’t trade, both, firms which found cutting pollution to be cheap and firms which found it to be expensive, would have to cut their individual level of pollution. However, through trade both firms can benefit: The low cost firm: cuts pollution further, sells its now excess permits at a profit The high cost firm: buys extra permits of the low cost firm, at a price lower than the cost of cutting pollution itself Result: total pollution is still reduced to the desired level, but in the least costly way possible

4. S Quantity Price Analysing the market for Permits: Supply of permits: The government issue a fixed amount of pollution rights in the economy (Q ). Therefore, supply is perfectly inelastic as it cannot change. Demand for permits: A firm would be willing to pay for a permit provided that is cheaper than cutting their pollution by a corresponding amount Equilibrium: The price of a permit equals P (S=D) Firms buy permits for P if this is cheaper than cutting their pollution Firms sell permits for P if this price is higher than cutting their pollution An increase in demand for pollution permits: Demand shifts from D to D1 Increased price of tradable permits results (P 1 ), but the same quantity trades Firms will either pay more for the right to pollute or they will be incentivised to reduce pollution. Those who do not need their permits can sell them on the market. Key Example: The EU has implemented Emissions Trading Scheme (ETS) The ETS covers more than 11,000 factories, power stations, and other installations D1 D P Q P 1 = Q 1

5. Pros and Cons of Tradable Pollution Permits Tradable Pollution Permits Mr O’Grady

6. Pros and Cons of Tradable Pollution Permits Pros: Internalise the external cost: Firms have an incentive to invest in cleaner technologies whenever they find the cost of investment is less than the revenue that they would receive from selling their permits Prioritise important industries: Permits are rationed to firms producing the most valuable/profitable goods. Allocatively efficient for society. Gov. Revenue: Selling permits raises funds that can be used to clean up the environment Dynamic: Permits can be gradually cut over time as part of a coordinated plan to cut overall pollution Provides commercial flexibility: firms can bank their excess permits for use in future years Cons: Recessions: If p roduction falls, firms pollute less and there is a glut of cheap permits. Limited incentive for firms to cut their emissions. Complex: Difficult to determine how many permits to allow. Example: at the start of ETS, permit prices were driven near zero as the EU misjudged how many to offer Hard to punish cheaters: Difficult and costly to measure how much a firm is polluting Transaction costs: Firms waste time and resources in buying and selling permits International competitiveness: firms move production abroad, where it is cheaper to pollute

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