Carbon Trading: Prices and Taxes - Assignment Example

Carbon Trading Part 1: The supply curve shifts left from S1 to S2. Price increases from P1 to P2. Quantity decreases from Q1 to Q2. Part 2: Carbon Tax A carbon tax approach to reducing emissions has three advantages over cap and trade. It is simpler to implement, has predictable costs and raises revenue. A carbon tax can be put into place with the few producers of fuel rather than having to tax the many emitters of greenhouse gases. A tax has a predictable effect on prices, so firms can plan for the increase in price.

Lastly a tax raises revenue that can then be used for investment in new efficient technology. Cap and Trade A cap and trade system has three advantages over a tax. It caps emissions at certain levels, allows the market to price those emissions, and gives all firms a profit incentive to reduce emissions. A cap sets a clear level of emissions, thus emissions targets can be met. Finally, firms can profit by investing in efficiency and selling the credits on the market. This creates an incentive to find cost effective technology for emissions reduction.

Analysis A carbon tax and cap and trade seek to do two things. Put a cost on emissions and reduce them. Both plans increase costs for firms but only one directly addresses the externality of emissions. I think cap and trade is a better solution. It directly reduces the externality and then lets the market set a price on that externality. This creates an incentive to create new technology and avoids firms cutting costs in other areas while continuing to produce emissions. Problem The firm is emitting 1000 tons more greenhouse gasses than it has credits for.

The cost to reduce emissions by 100 tons is $250,000. Calculate reduction cost per ton of emissions: $250,000/1000 tons = $250/ton. Each ton of emissions has a cost of $250. If credits on the market sell for less than $250, then the firm should buy credits. If they sell for more than $250, the firm ought to invest in efficiency. References “Putting a Price on Carbon: An Emissions Cap or a Tax?” Yale Environment 360. Web. May 7, 2009.