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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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A Carbon Tax versus an ETS

Both the carbon tax and the ETS place a 'price on carbon' and help to re-allocate resources to the use of alternative forms of energy, resulting in cleaner production over time.  However, a major difference between the tax and the ETS is that the carbon tax directly targets the price of carbon (via the imposition of the tax), with the market determining the volume of Co2 emissions that will occur. In contrast, the ETS directly targets the volume of Co2 emissions (and issues permits consistent with this volume) and then allows the market to determine the price.  

Fundamentally, the ETS has the advantage of greater control over the actual level of carbon pollution.  Once the government sets the legally permissible level of carbon emissions, it allows the 'market' to determine the most efficient means of achieving these levels.  The carbon tax, on the other hand, will reduce emissions levels, but there is less certainty about the actual level of pollution abatement that would occur.  In this respect, the quantity of Co2 emissions is variable under a carbon tax, unlike the ETS, where the price is variable and level of Co2 emissions is fixed by the government.  

Whilst the carbon tax provides greater certainty for businesses about the costs of polluting, its inability to accurately control the actual level of Co2 emissions leads to a sub-optimal level of pollution abatement if the tax is not set at the correct level.  For example, a carbon tax of $23 per tonne of Co2 emissions will result in affected industries increasing their prices.  If consumers are unresponsive to the price increases (e.g. because consumers have a low price elasticity of demand for carbon intensive products, such as electricity) then the carbon tax results in a minimal reduction in carbon emissions.  (However, as the carbon tax increases over time, the relative price attractiveness of alternative energy increases, thereby helping to reduce emissions this way.)

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