Microeconomics: Principles, Problems, & Policies, 20th Edition

Published by McGraw-Hill Education
ISBN 10: 0077660811
ISBN 13: 978-0-07766-081-9

Chapter 4 - Market Failures: Public Goods and Externalities - Discussion Questions - Page 105: 9


Carbon taxes are imposed on the amount of carbon emitted by firms, and are usually charged per ton of carbon emission. In this case, firms would have to pay the government a tax unless they emit below the limit set by the government. Cap- and- trade strategy involved the government issuing tradable tax permits to firms, where each permit allows the firm to emit a certain amount of carbon. This would incentive firms to lower their emission of carbon, so that they would be able to sell their permits to firms that require more permits to emit more carbon (usually larger firms that can afford it and have large production). The more popular option would usually be cap-and-trade strategy, as it directly gives firms the incentive to lower their production, and would not cause the price of goods to increase, and consumers would not need to bear the burden to increased cost, which they would have to if a tax is imposed.

Work Step by Step

As can be seen from the diagram, a tax imposed on carbon would increase the price of the good that firms are selling from P0 to P1, and hence consumers would have to bear the cost of the shaded area, and thus this would not be well received as compared to cap-and-trade , where there would not be cost increases for most consumers.
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