Cambridge International as and a level Economics Ebook

pollution 
permits
. Unlike indirect taxation and regulations, 
pollution permits are a free market solution as they can 
be bought and sold. Th
ey are issued by governments or, as 
with the Emissions Trading Scheme (ETS), the European 
Union. Polluting fi rms (and also airlines) are given a 
certain number of ‘permits to pollute’ over a given time 
period. If a fi rm emits a lower level of pollution, it can 
sell its spare permits in the market to fi rms needing to 
buy more permits since they have used up those allocated 
to them. As well as the EU, similar permit schemes are 
in place in Australia, China and Singapore; the USA has 
recently introduced a ‘cap and trade’ system for reducing 
carbon emissions.
Figure 8.5
 shows how the system operates. When 
introduced, the supply of pollution permits is 
S
0
with a 
demand of 
D
0
. Th
e market price is therefore 
P
0
. Assume 
over time that demand increases (more pollutants are 
being emitted); with supply fi xed at 
S
0
, the price rises to 
P
1
, giving every incentive to polluting fi rms to be more 
environmentally effi
cient. A more ambitious approach, as 
being applied in the US’s Green Budget, is to reduce the 
number of permits available over time. Hence, the supply 
curve shift s left to 
S
1
, with the price of permits rising to 
P
2
. 
Th
is puts even more fi nancial pressure on fi rms to invest in 
cleaner technologies, so cutting greenhouse gas emissions.
Th
e use of pollution permits has many attractions but 
they are not without their critics. Th
e EU’s ETS, introduced 
in 2005, has suff ered from an oversupply of permits mainly 
as a consequence of how global recession has hit industrial 
production. Th
e price of permits peaked at €30 in 2008; in 
2013 the price was around €5. Such low prices are unlikely 
to provide the incentive many fi rms need to reduce their 
greenhouse gas emissions. One likely solution, as indicated 
in 
Figure 8.5,
 is to cut back on the supply of permits (see 
the box ‘China’s fi rst carbon trading programme’).
A fourth way to correct this type of negative externality 
is by means of 
property rights
. As the name indicates, 
individuals, fi rms, governments and others have the right 
to own resources such as housing, factories, mines, farms, 
rivers and so on. Th
is is a central feature of a capitalist 
economy. Th
is right gives the owner the legal right to use