Carbon trading is the process of buying and selling carbon credits. Large companies or organisations are assigned a quota of carbon that they are allowed to emit. If a company’s emissions are less than its quota then it can sell credits if emissions are more then it will need to buy carbon credits. This may be effective in the way that companies will try to reduce their carbon emissions in order to reduce cost incurred from purchasing extra carbon credits.
However this may not be effective if the opportunity cost for reducing their carbon emissions may be greater than if they spent the extra amount of money to purchase other company’s carbon credits. Therefore there will not be much of a change in a company’s emissions. Therefore this will only be effective if the government enforces to a certain standard as if they do not then company’s may disregard it and continue polluting. “Developing countries would face a lower burden in reducing emissions than developed countries”.
This is because developed countries have more industries such as steal which require huge amounts of carbon to be exerted into the atmosphere, whereas developing countries won’t have many of these industries and it will be easy for them to stay below their quota and may then even be able to sell their permits to more developed countries on the open market. You will also need tight limits on regulations, we need huge transfers of wealth to poorer countries to be effective as these countries may not be able to afford the permits if they end up going over their limit.
The supply of these permits are fixed. Therefore if there is an increase in demand for permits from D to D1 then this will cause an increase in price from P to P1. However the quantity supplied will remain the same as governments only provide a limited amount of permits which are not determined by demand. We also need to look at the efficiency of carbon trading, this is whether it produces Allocative and productive efficiency. If any of these methods are economically efficient, then they should produce at the Social Optimum Output.
There are many market failures that are linked with the global problem of emissions. These are; demerit goods. These are goods that we over consumed and overproduced from the consumer’s or society’s point of view due to information failure. Another market failure is merit goods. These are; goods that are under consumed and under produced because there are benefits to consumers or society beyond those consumers consider because of information failure. Private and public goods are also market failures.
Private goods are those over which there are private property rights. Public goods are goods that are non-rivalry and non-excludable. Another market failure is the existence of free riders. There are many free riders as it saves costs and money just to ignore these emissions. There are many different ways to reduce emissions. These are regulations, subsidies and carbon trading. The government could also use carbon taxing, this is a tax on the carbon a company produces.
Meaning companies will be charged for the amount of carbon they produce. However it will be difficult for the government to enforce this as they will need to spend lots of money to keep an eye on businesses and measure hw much carbon they produce and it will also be difficult to determine the right price for tax and it will need to be a large and sustained tax to have any real effect. Carbon tax might be more certain as it wont collapse in a recession like now.
It gives firms clarity and certainty as they know exactly how much they save if they reduce emissions, therefore this should increase investment because any stability does. Governments don’t like tax incentives because of the perverse incentive effect as firms are encouraged to move abroad where they aren’t taxed. Another alternative would be subsidising polluting firm so they can innovate and create products or invest in new capital which is green and uses renewable energy. Subsidies are government grants given to firm and act as a cut in the cost of production.
However the effectiveness of the subsidy will depend on how big the subsidy is and if it is sustained. As if it is too small then it will not have much affect, it also needs to be sustained to have any real impact on the levels of carbon emissions. These subsidies could be provided to poorer countries, however they will need to see if the subsidy if being spent correctly and not being misused or pocketed by officials. Regulations are rules made by a government or other authority in order to control the way something is done.
These should effective if the governments have tight restrictions on the amount of carbon emissions a firm is allowed to produce. Governments will need to enforce some discipline like France is trying to do as it is saying that “failure to meet agreed targets would result in trade sanctions and tariffs to provide countries with incentives to honour their commitments”. However it will be difficult as this will be very costly to enforce and it will be difficult to keep control of all polluting firms.
Overall I believe it would be best to go ahead with carbon trading as it does not have any perverse incentives and it allows non-polluting firms to benefit and encourages others to want to benefit from these extra profits from selling their permits to other companies. The other alternatives may be good in some circumstances such as in a recession where carbon taxing will excel as it is certain unlike carbon trading where firms may not be able to sell their permits and thus the incentive to reduce their emissions will be gone.