e. Given your answers to parts (c) and (d), what is the
implication for the path of GHG/Energy if overall GHG
emissions are to be reduced significantly?
10. The European Union has a system for tradable permits for the
emission of greenhouse gases. The authorities initially set the cap
on emissions at a level that was expected to generate a permit
price of about 20€ per tonne of emissions, and during the early
2000s the equilibrium price was close to 20€.
a. During the global recession of 2008–2009, many
European firms reduced their output of goods and
services. Why would this also reduce their demand for
emission permits?
b. Could this explain why the market price for permits fell to
as low as 7€ per tonne during this period? Explain.
c. Some commentators have argued that the observed price
volatility within the European trading system shows that
a cap-and-trade system does not work in practice, even
though it has theoretical appeal. Does a properly
functioning cap-and-trade system display constant permit
prices? Why or why not?
d. Is there a particular problem associated with volatile
permit prices in a cap-and-trade system? (Hint: Consider
firms’ incentives to make investments in either using or
developing non-emitting technologies.)
