What is the effect of a tradable permits system on emission reductions?

• A. Firms with lower abatement costs sell permits to others, achieving cost-effective reductions.
• B. All firms must reduce emissions by the same percentage.
• C. Permits improve compliance through penalties.
• D. Permits increase overall emissions.

Answer: (A)

Tradable permits create a market for emission rights. The government caps total emissions and issues permits equal to that cap, which can be bought and sold. Firms whose abatement costs are low will reduce more emissions at a low cost and can sell their extra permits to firms facing higher abatement costs. This reallocates reductions to the places where they cost the least, so the overall target is achieved at the lowest total cost. The cap ensures the desired level of emissions, while the trading mechanism drives cost efficiency. Penalties matter for compliance, but the key effect on reductions is that low-cost abaters sell permits to higher-cost firms, enabling cost-effective reductions.