Cap and Trade 101
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Transcript of Cap and Trade 101
Cap and Trade 101
Marlon G. BoarnetProfessor of Public Policy
Director of Graduate Programs in Urban Planning and Development
University of Southern California
July 10, 2010
• An externality occurs when a market transaction affects a party who neither pays not gets paid
Externalities
Q (Televisions)
MPC
D = MPB
$
Qp
MPC = marginal private cost
MPB = marginal private benefit
Q = quantity consumed (purchased)
Private Markets
• An externality occurs when a market transaction affects a party who neither pays not gets paid
Externalities
Q (Televisions)
MPC
D = MPB
$
Qp
MPC = marginal private cost
MPB = marginal private benefit
Q = quantity consumed (purchased)
Private Markets
= MSC
= MSB
MSC = marginal social costMSB = marginal social benefit
• An externality occurs when a market transaction affects a party who neither pays not gets paid
Externalities
MPC
D = MPB
$
Qp
MPC = marginal private cost
MPB = marginal private benefit
Q = quantity consumed (purchased)
Markets with ExternalitiesMSC
Q* Q (Driving)MSC = marginal social costMSB = marginal social benefit
Social cost exceeds social benefit for these trades
Photos: SQ AQMD and Los AngelesTimes
Regulatory Approaches
• Price Controls (taxes)– Example: Value Pricing on
SR-91• Quantity Controls
(mandated limits)– Example: Clean Air Act
compliance• Emission Clean-Up
(mandated technology)– Examples: Catalytic
Converters; Unleaded Fuel
MPC
D = MPB
$
Qp Q (Driving)
Social cost exceeds social benefit for these trades
MSC
Q*
Tax = (MSC – MPC)
Mandated emissions limit
Efficiency of Regulatory Approaches (Theory)
• Price Controls (taxes) and Quantity Controls (mandated limits)– Both lead to efficient externality reduction (to point
where social costs of activity = social benefits)– Difference is in information available to regulator
• Emission Clean-Up (mandated technology)– Can regulator “pick” the right technology?– Why not let market forces choose clean-up
technology?
Efficiency of Regulatory Approaches (Practice)
1980 1990 20000
20
40
60
80
100
120
140
117
41
0
LA County population (100,000s)LA City Stage 1 Smog Alert Days
Year
27% pop growth LA County (7.4 to 9.5 million)
Stage 1 days from 117 (in 1978) to 0 (late 1990s)
Data: SC AQMD and US Census
Market Based Regulatory Mechanisms• Price Controls (taxes)• Quantity Controls (mandated limits)– Cap and Trade – Variation on Quantity Control
• Emission Clean-Up (mandated technology)
• Incentive vs. outcome regulation• Advantages of market based regulations– Creates incentives for clean-up– “self regulating” – uses incentives and markets to
coordinate actions
Market based
Cap and Trade• Economy-wide cap on emissions (quantity regulation)– Similar to Clean Air Act concentration levels for traditional
pollutants• Firms get emission permits, which can:– Be used for emissions, or– Sold to firms that want extra permits
• Permits “depreciate” over time – cap binds more• Firms that can clean up inexpensively will do more
cleanup to sell permits to “dirty” firms• More emission reduction from firms that can reduce
emissions at lower cost
Exampledirty clean
Firm 1 Firm 2$300 $100 cost for reducing 1st ton of CO2e$500 $200 cost for reducing 2nd ton of CO2e$700 $300 cost for reducing 3rd ton of CO2e
$1000 $500 cost for reducing 4th ton of CO2e
both firms initially produce four tons CO2e
reduce four tons, two from each firm, cost = 1,100two permits per firm and can trade, cost = 900
Firm 2 will sell a permit to Firm 1 at any price higher than $300Firm 1 will buy a permit from Firm 2 at any price lower than $500
Does it work?• SO2 permit market, Clean Air Act Amendments
of 1990; RECLAIM SCAQMD• Conditions for Cap and Trade to be successful
and issues– No “hot spots” – location of emissions is no concern– Sufficient number of permit-holders for market to
work– Neither a shortage nor surplus of permits– Initial permit allocation issues
ARB Cap and Trade• Economy-wide cap: 1990 CO2e emissions by 2020• Price stability measures – reserve permits to offer
on market and effort to not be too slack• Distribute early permits by allocation, auction later
permits• Measures to reward prior energy efficiency with
permit allocation• Economic impacts mostly distributional– 2.3% state GSP growth per year 2007-2020 vs. 2.4%
“business as usual”
Use of Auctioned Permit Revenues
• Reduce distorting taxes• Dividends to consumers• Clean energy?• High speed rail?