What is emissions trading and what is it good for? Part 2 of 2

Instruments that have the power to reduce pollution emissions are one of the topics we study in our course, and looking closer on certain issues it can get sometimes more technical to understand problems better.

Emission trading was first developed as an economic theory to internalize damaging externalities like pollution, which means that negative effects on the welfare of another entity have to be considered if we want to achieve a specific goal at least-cost. The creation of a cap-and-trade market based framework is able to resolve this kind of problems. The cap is a limit on emissions that can not be exceeded; usually policy makers  decide it on an arbitrary level and it gets lowered over time. The “trade” part of this system is the market, where a price gets associated to a ton of pollutants. But there is only a limited number of certificates available on the market, and according to market dynamics regulate itself to reach a certain pricing level that can be cost efficient in some specific circumstances.

As I mentioned in the first part, there are some other instruments that can handle pollution reduction problems like carbon taxes or command and control incentives (I will report about those two in the near future). The main advantage of emission trading is that it can handle a lot of problems that the other two can not.

Of course this is just a very basic overview of what emission trading is about, but in the case you want to learn more about this kind of approach you should definitely consider to read through some more detailed lecture.

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