Figure 17-6 The Market for Permits in a Cap-and-Trade System
—the government-mandated “cap” on pollution. Let this amount be
is represented by a vertical supply curve in Figure 17-6. The demand for
pollution permits comes from firms and depends on their costs of
pollution abatement.
The equilibrium price in the market for pollution permits is
determined by government policy and by firms’ technology of
pollution abatement. In a cap-and-trade system, the government sets the
total quantity of pollution permits at. This is the vertical supply curve.
At a lower price for permits (the marginal benefit of abatement) firms
decide to abate less pollution and they therefore require more pollution
permits. The demand curve for permits is therefore downward sloping. At
the equilibrium price, the quantity of permits demanded by firms is equal
to the number issued by the government.
For every unit of pollution that a firm abates, the firm requires one fewer
pollution permit. The price of the pollution permit is therefore the firms’
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