Final answer:
Cap-and-trade is a system that controls pollution by setting a cap on emissions and creating a market for emissions permits, allowing firms to buy and sell the right to emit pollutants. Its flexibility is a key feature, but drawbacks include potential local impacts and issues with permit allocation. It is most effective for large, identifiable sources of pollution and can be combined with pollution taxes for better coverage.
Step-by-step explanation:
Tradable emissions permits, also known as cap-and-trade, are a market-oriented environmental policy tool used to control pollution by providing economic incentives for achieving reductions in the emissions of pollutants. A government sets a cap on allowable emissions and distributes permits to firms that represent the right to emit a certain amount of pollution. Firms that can reduce emissions at a lower cost can sell their extra permits to others, creating a market for emissions allowances.The main features of cap-and-trade include its flexibility and its ability to put a clear limit on pollution. One potential drawback is that it can lead to disproportionate impacts on communities that are located near heavy polluters who buy additional permits. Additionally, establishing the initial distribution of permits can be contentious, whether they are auctioned or allocated for free. For large-scale pollutants where the sources are few and identifiable, cap-and-trade systems work particularly well, such as with utilities trading sulfur dioxide permits. However, marketable permits are less effective for widespread, diffuse sources of pollution like car emissions or unrecycled waste.Market-oriented tools can be combined, such as using marketable permits along with a pollution tax for emissions not covered by a permit. This combination can offer a more comprehensive approach, as it leverages improved property rights provided by the permits along with the economic disincentive of taxes.