Discuss the effectiveness of tradable permits in correcting market failure.
Tradable permits are a cost-efficient, market-driven approach to reducing greenhouse gas emissions. Tradable permits allow polluters to emit a certain amount of pollution and if un-used or partially used can be sold to others. A government must start by deciding how many tons of a particular gas may be emitted each year. Increased carbon emissions are an example of market failure. This is where the free market fails to achieve an efficient allocation of resources. This can result in a loss of economic and social welfare. Market failure exists when the competitive outcome of markets is not efficient from the point of view of society as a whole. Tradable permits are an effective way of correcting market failure as they attempt to achieve government objectives of reducing emissions. An alternative to full allocation of property rights is for governments to cap pollution at what they judge to be the optimal level. Firms are then allocated permits to allow them to emit a certain level of pollution in an agreed time period (say a year) but can sell any permits that they do not need to other firms. Such emissions trading or cap and trade schemes have become increasingly prominent and have been extended to international agreements, where countries have permits to produce agreed levels of pollution but can sell these permits to other countries if they wish. By having a set amount of pollution allowed by the government, the demand for tradable permits increases and so does the price, encouraging firms not to pollute as shown on the diagram below.
From the diagram what can be seen is that the supply of pollution rights remains constant and is fixed because the quantity is determined by officials based on environmental studies depending on current pollution levels. However there is a rightward shift in the in the demand curve from D1 to D2 and as a result price...
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