Cap and Trade

Cap and Trade - Cap and Trade...

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Cap and Trade Economics of international emissions trading It is possible for a country to reduce emissions using a Command-Control approach, such as regulation, direct and indirect taxes . The cost of that approach differs between countries because the Marginal Abatement Cost Curve (MAC) — the cost of eliminating an additional unit of pollution — differs by country. It might cost China $2 to eliminate a ton of CO 2 , but it would probably cost Sweden or the U.S. much more. International emissions-trading markets were created precisely to exploit differing MACs. Example Emissions trading through Gains from Trade can be more beneficial for both the buyer and the seller than a simple emissions capping scheme. Consider two European countries, such as Germany and Sweden . Each can either reduce all the required amount of emissions by itself or it can choose to buy or sell in the market. Example MACs for two different countries
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For this example let us assume that Germany can abate its CO 2 at a much cheaper cost than Sweden, e.g. MAC S > MAC G where the MAC curve of Sweden is steeper (higher slope) than that of Germany, and R Req is the total amount of emissions that need to be reduced by a country. On the left side of the graph is the MAC curve for Germany. R Req is the amount of required reductions for Germany, but at R Req the MAC G curve has not intersected the market allowance price of CO 2 (market allowance price = P = λ ). Thus, given the market price of CO 2 allowances, Germany has potential to profit if it abates more emissions than required. On the right side is the MAC curve for Sweden. R Req is the amount of required reductions for Sweden, but the MAC S curve already intersects the market price of CO 2 allowances before R Req has been reached. Thus, given the market allowance price of CO 2 , Sweden has potential to make a cost saving if it abates fewer emissions than required internally, and instead abates them elsewhere. In this example, Sweden would abate emissions until its MAC S intersects with P (at R*), but this would only reduce a fraction of Sweden’s total required abatement. After that it could buy emissions credits from Germany for the price P (per unit). The internal cost of Sweden’s own abatement, combined with the credits it buys in the market from Germany, adds up to the total required reductions (R Req ) for Sweden. Thus Sweden can make a saving from buying credits in the market ( Δ d-e-f). This represents the "Gains from Trade", the amount of additional expense that Sweden would otherwise have to spend if it abated all of its required emissions by itself without trading. Germany made a profit on its additional emissions abatement, above what was required:
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Cap and Trade - Cap and Trade...

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