Question

a) Use a graph to explain how an emission-trading scheme operates.  

b) Name two (2) countries that have introduced an emission-trading scheme.

Answer 1

a) An emission trading scheme is a trading system in which the government would set a limit on the emissions and defines the permits up to the level of allowed limit. It would give permit to the participants equal to each participant’s baseline emissions. The baseline in such a system would be determined by the historical emission standards that are set by the countries. Thus, a compliance by each participant would mean that the total emissions would be equal to the sum of the maximum limit of the individual emissions. Thus, if the nation emits less than the individual limits set, then it may permit the nation to sell the excess of the same in a trading manner. It is also called as the cap and trading system which is regarded as the most environmentally and economically sustainable and sensible approach to controlling the greenhouse gas emissions. Thus, it is a market based approach that would help control the rate of pollution by providing economic incentives for the nations that would reduce the emissions to the set standards. The nation that wants to increase the emissions would have to buy them from other nations who are willing to sell them. These financial instruments may be traded in the secondary market.

                        A Lagrange framework is used to determine the least cost of achieving an objective, in this case the total emission reduction in a year. Lagrange optimisation framework is used to determine the required reductions for each country so that the total cost of reduction is minimised. Here, the Lagrange multiplier would represent the market allowance price of a pollutant such as the current market price of emission permits in a nation. As the economic conditions change, the price value would fluctuate in the economy and the graphical analysis would determine the cap that has to be allowed to meet the requirement in the given economic situation. The demand in the market and the corresponding market fluctuations would also induce variations in the pricing mechanism in the market and thus would determine the price fluctuations in the graphical analysis. Thus, based on the demand-supply criteria and the price fixation mechanism along with the base permit levels, the price controlling mechanism and the trading mechanism may be fixed with the help of graphical analysis.

b) NewZeland and Switzerland are the two major economies that uses this concept of emissions trading.