Cap and trade

Definition

Cap and trade is an environmental policy tool that aims to reduce greenhouse gas emissions by setting a limit (cap) on the total amount of emissions allowed from specific sources. Companies are allocated or can purchase allowances for their emissions, which they can trade with other companies, creating a market for emissions reductions. This system incentivizes businesses to lower their emissions as they can profit from selling excess allowances.

5 Must Know Facts For Your Next Test

1. The cap and trade system was first implemented in the United States during the Acid Rain Program in the 1990s, successfully reducing sulfur dioxide emissions.
2. Under cap and trade, firms that lower their emissions below their allowance can sell their excess credits to other companies that exceed their limits.
3. The cap is gradually lowered over time to achieve greater emission reductions, creating a declining total limit on emissions.
4. Cap and trade has been adopted in various regions around the world, including the European Union Emission Trading System (EU ETS) and California's cap-and-trade program.
5. Critics argue that cap and trade may allow some companies to continue polluting if they can afford to buy additional allowances, leading to inequities in environmental impacts.

Review Questions

• How does the cap and trade system create economic incentives for companies to reduce their greenhouse gas emissions?
  • Cap and trade creates economic incentives by allowing companies that reduce their emissions below the allocated cap to sell their excess allowances to other companies that need them. This trading mechanism encourages businesses to invest in cleaner technologies and practices since they can earn revenue by selling their unused credits. As the cap tightens over time, the demand for these allowances increases, further incentivizing companies to decrease emissions in order to remain competitive.
• Evaluate the effectiveness of cap and trade compared to direct regulation methods in controlling greenhouse gas emissions.
  • Cap and trade is often seen as more flexible and cost-effective than direct regulation because it allows companies to choose how best to meet their emission reduction targets. While direct regulation sets specific limits for each company, cap and trade encourages innovation by letting firms find the most economical ways to reduce emissions. However, the effectiveness of cap and trade can vary based on factors like market design, enforcement, and how well the cap reflects actual emission reduction needs.
• Synthesize information about how cap and trade systems can lead to both environmental benefits and economic disparities among different sectors or communities.
  • Cap and trade systems can lead to significant environmental benefits by effectively reducing overall greenhouse gas emissions through market mechanisms. However, these systems may also create economic disparities since larger or wealthier companies might be able to purchase more allowances, while smaller firms or disadvantaged communities may lack resources for compliance or investment in cleaner technology. This can result in unequal pollution burdens, where vulnerable communities continue to experience higher levels of pollution while larger corporations benefit economically from trading in credits, necessitating careful policy design to ensure equitable outcomes.

Related terms

Emissions trading: A market-based approach to controlling pollution by providing economic incentives for achieving reductions in the emissions of pollutants.

Carbon credits: Permits that allow the holder to emit a certain amount of carbon dioxide or other greenhouse gases; one credit typically represents one metric ton of carbon dioxide.

Regulatory cap: The maximum limit imposed by authorities on the total amount of greenhouse gases that can be emitted by regulated entities within a specific timeframe.