Lecture Notes: Tradable Permits and Environmental Economics

Introduction to Tradable Permits

• Tradable permits combine cost mechanisms and command-and-control strategies.
• The Clean Air Act success:
  • SO₂ emissions have decreased.
  • Electricity generation has increased.
  • Market efficiency in reducing pollution has been observed.

Functioning of Tradable Permits

• Clean energy firms can profit by selling allowances.
• Dirty energy firms must purchase allowances, effectively taxing them.
• Encourages clean energy and discourages dirty energy without taxpayer subsidy.

Participation in Tradable Permit Markets

• Open to all, not limited to electricity generators.
• Example: Tyler Cowen and Alex purchased and destroyed emission rights to reduce pollution.
• Environmental groups can purchase and destroy permits to decrease pollution independently.

Comparison with Pigouvian Taxes

• Similar economic outcomes if taxes = external costs and allowances = efficient quantity.
• Political differences exist, notably initial allocation of allowances.
• Allocation strategies:
  • Allowances can be auctioned for governmental revenue.
  • Initial allocation to firms increases political acceptance.

Political Considerations

• Initial allocations can reduce resistance from large energy firms.
• Tradable allowances are politically more palatable than direct taxes.

Application to Global Climate Change

• Theoretically applicable to carbon dioxide emissions.
• Global climate change needs global cooperation, unlike sulfur dioxide which was controlled nationally.
• International externalities pose a challenge.

Importance of Economics

• Both tradable permits and Pigouvian taxes are cost-effective pollution control methods.
• Lowering pollution control costs increases likelihood of achieving emission reductions.
• Understanding economics aids in devising effective environmental policies.

Conclusion

• Tradable permits provide efficient pollution control with significant economic and political implications.
• Effective for national issues and theoretically applicable to global problems like carbon emissions.