Tradable Permits

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Definition of Tradable Permits

The contemporary economists attempt to achieve environmental objectives using market based policies or indirect taxes. The taxes and programs are developed because the government attempts to limit the overall pollution that factories and industries excerpt. The most important aspect of tradable permits is that they can be traded between firms. This market based system allows firms to reduce pollution at the lowest cost possible. Unlike command economies that specify which technology the firms are allowed to use to manufacture with. However, there are problems that are accompanied with this market based system of issuing permits. And moreover these conflicts cannot be avoided so easily. This essay analyzes the exact method that governments use to issue the permits and whether or not these permits really help the economy and the environment as much as they should.

However, in order to analyze such an issue accurately, one would need to know exactly what tradable permits are and how they are used. The tradable permits are also known as tradable environmental allowances. The basic idea of issuing the permits is a variation on regulating negative externalities using indirect taxes. The actions that the permits allow can be categorized as the emitting or extracting of pollution. These permits allow industries to emit a certain level of pollution, if they exceed these levels then the firm would be forced to pay fines. Of course, an accredited verifier must verify the amount of greenhouse gases emitted. Otherwise the amount of greenhouse gases could not be monitored. An example of the attempted preservation of the environment may be, that an industry may only emit a tone of sulfur dioxide over a year but, next year the permit will lower the amount of sulfur that is allowed to be produced. Thus, firms most invest more money into machinery that is more environmentally friendly. Since tradable permits can be traded, the permit will move to its most efficient user. In other words, once an industry has purchased a permit from the government and it has successfully reduced its emissions, the firm can sell its permits to an industry that is exceeding its level of pollution. Therefore, environmental goals will be achieved at substantial cost savings for firms.

In terms of helping society the tradable permit system can be understood better with the use of a diagram. The diagram below called “the Diagrammatic Representation of Taxation on Negative Externality,” represents the system of the tradable permits. The points A, B and C form a triangle, which illustrates the vastness of the negative externality. It is the cost of the negative externality. The diagram also shows that the pollution has caused a shift in the marginal social cost at point A to point C. The marginal social cost is now lower in price but, higher in the quantity of pollution. The green arrow represents the shift in the marginal social cost, which is caused by pollution. The red arrow represents the shift that could be caused through the use of tradable permits. In other words, the government is trying to shift the marginal private cost to the left using the tradable permits system, in order to lower the amount of pollution excreted at substantial cost savings.

Diagram 1: Diagrammatic Representation of Taxation on Negative Externality.

The largest and probably most important emissions trading scheme was developed by the European Union. The EU applies its program in 25 different countries. The European Union has decided to run a trial phase just to make sure the program works well. The trial runs from 2005 to 2007. The trial phase and perhaps real phase coincide with the first Kyoto Protocol rule. The second phase commences in 2008 and ends in 2012. The Kyoto Protocol commitment basically tells countries how much they are expected to reduce the level of their emissions. The...
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