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 Course notes quick navigation

1 Introductory concepts 2  Market mechanism  3 Elasticities  4 Market structures 5  Market failures  6  Macro economic activity/eco growth  7 Inflation 8  Employment & unemployment  9  External Stability  10  Income distribution 11.Factors affecting economy  12  Fiscal/Budgetary policy  13  Monetary Policy   14 Aggregate Supply Policies  15 The Policy Mix

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Emissions Trading Scheme

It is generally accepted that an Emissions Trading Scheme (ETS) is the most efficient method of combating the threat of climate change.  An ETS typically involves a government determining a base level of carbon emissions it will tolerate in the economy.  The government then provides or sells a certain number of permits to businesses allowing them to release Co2 into the atmosphere and enforces penalties for polluting without permits.  Once the permits are held by businesses, they can sell some of these to other businesses (or polluters), and a 'carbon market' develops, with a demand, supply and price for carbon.  

The least efficient polluters will demand more permits compared to those businesses that are more successful at pollution abatement (who can then supply permits in the carbon market).  If Co2 levels are too high, the price of permits rise, (i.e. the costs of polluting for businesses will be higher), providing incentives for businesses to reduce their demand for permits (or increase their potential supply). Businesses will seek to achieve a reduction in pollution in various ways, such as employing the latest pollution abatement methods (or technologies), investing in alternative energies or purchasing carbon offsets (such as investing in forest plantations).

Over time, the government reduces the number of permits in existence (effectively reducing supply), forcing up the price of CO2 permits, and providing even further incentives for businesses to reduce their Co2 emissions.  The relative price of other 'renewable' forms of energy (such as wind and solar) will decrease, creating greater investment and innovation in that sector.  Overall, pollution levels drop in line with the reductions in permits, and any existing level of Co2 emissions is achieved in the most efficient way.

The ETS will result in a price will increase for those goods and services relying heavily on non-renewable energy (such as coal fired electricity) relative to the price of other goods and services.  In this respect, an ETS effectively works like a tax, adding to the costs of production for those producers and raising prices.  Consumers will then tend to switch to the consumption of those goods and services not subject to the tax - i.e.  goods or services that are now relatively cheaper and cleaner for the environment.

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