Market Failure and Carbon Prices

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Market Failure and Carbon Prices

Climate change has become an issue of global discussion and it is the result of market failure. The effects of the increasing volume of carbon dioxide and greenhouse gases on the global temperature have become a major environmental issue throughout the world. Carbon emissions worldwide need to be reduced in order to avoid serious climate change. To encourage companies to invest in cleaner technology and reduce carbon emissions, the government has to attach a cost to carbon emissions. There are a few approaches to limiting carbon emissions such as the cap-and-trade system and carbon tax (‘Good policy, and bad’ 2009). Government intervention can correct the distortions by market failure to improve economic efficiency. Hence, world leaders need to implement a carbon price in order to reduce the negative externalities which cause market failure.

Market failure is the situation in which the market fails to produce the efficient level of output (Hubbard et al. 2009). The failure occurs due to the existence of negative externalities (in the case of the environment). Greenhouse gas emission and air pollution produced by power companies and manufacturers are examples of negative externalities. Negative externalities are the costs that affect someone who is not directly involved in the production of a good or a service (Hubbard et al. 2009). People with respiratory illness bear a cost even when they were not directly involved in the buying or selling of the electricity that caused the pollution.

Externalities distort the economic efficiency of the market equilibrium. There is a difference between private costs and social costs to society overall due to a negative externality. Private cost is the cost borne by the producer of a good or service while social cost is the private cost plus external cost resulting from production, such as the cost of pollution (Hubbard et al. 2009). Private cost and social cost will be equal in the...
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